CFA Level 1 - Portfolio Management Session 12 - Reading 43

CFA Level 1 - Portfolio Management Session 12 - Reading 43 (Notes, Practice Questions, Sample Questions) 1. In the Markowitz framework, an investor should most appropriately evaluate a potential investment based on its: A)intrinsic value compared to market value. B)effect on portfolio risk and return. (Explanation: Modern portfoliotheory concludes that an investor should evaluate potentialinvestments from a portfolio perspective and consider how theinvestment will affect the risk and return characteristics of aninvestor’s portfolio as a whole.) C)expected return. 2. The ratio of a portfolio’s standard deviation of return to the average standard deviation of the securities in the portfolio is known as the: A)Sharpe ratio.B)relative risk ratio. C)diversification ratio. (Explanation: The diversification ratio iscalculated by dividing a portfolio’s standard deviation of returns bythe average standard deviation of returns of the individualsecurities in the portfolio) 3. High risk tolerance, a long investment horizon, and low liquidity needs are most likely to characterize the investment needs of a(n): A)insurance company.B)bank. C)defined benefit pension plan. (Explanation: A defined benefitpension plan typically has a long investment time horizon, low

liquidity needs, and high risk tolerance. Insurance companies andbanks typically have low risk tolerance and high liquidity needs.Banks and property and casualty insurers typically have shortinvestment horizons) 4. Which of the following statements about the steps in the portfolio management process is NOT correct? A)Developing an investment strategy is based on an analysis ofhistorical performance in financial markets and economicconditions. (Explanation: Developing an investment strategy isbased primarily on an analysis of the current and future financialmarket and economic conditions. Historical analysis serves to helpdevelop an expectation for future conditions) B)Rebalancing the investor’s portfolio is done on an as-needed basis,and should be reviewed on a regular schedule.C)Implementing the plan is based on an analysis of the current andfuture forecast of financial and economic conditions 5. Which of the following is generally the first general step in the portfolio management process? A)Develop an investment strategy. B)Write a policy statement. (Explanation: The policy statement isthe foundation of the entire portfolio management process. Here,both risk and return are integrated to determine the investor’sgoals and constraints) C)Specify capital market expectations. 6. Which of the following would be assessed first in a top-down valuation approach? A)Fiscal policy. (Explanation: In the top-down valuation approach,the investor should analyze macroeconomic influences first, then

industry influences, and then company influences. Fiscal policy, aspart of the macroeconomic landscape, should be analyzed first ) B)Industry return on equity (ROE).C)Industry risks. 7. In the top-down approach to asset allocation, industry analysis should be conducted before company analysis because: A)most valuation models recommend the use of industry-wide averagerequired returns, rather than individual returns.B)the goal of the top-down approach is to identify those companies innon-cyclical industries with the lowest P/E ratios. C)an industry's prospects within the global business environmentare a major determinant of how well individual firms in the industryperform. (Explanation: In general, an industry’s prospects withinthe global business environment determine how well or poorlyindividual firms in the industry do. Thus, industry analysis shouldprecede company analysis. The goal is to find the best companiesin the most promising industries; even the best company in a weakindustry is not likely to perform well) 8. A pooled investment with a share price significantly different from its net asset value (NAV) per share is most likely a(n): A)open-end fund.B)exchange-traded fund. C)closed-end fund. (Explanation: Closed-end funds’ share pricescan differ significantly from their NAVs. Open-end fund shares canbe purchased and redeemed at their NAVs. Market forces keepexchange-traded fund share prices close to their NAVs becausearbitrageurs can profit by trading when there are differences)