AIP Portfolio Management & Asset Allocation 4 — Questions and Answers
Question 1: A 60/40 equity/bond portfolio drifts to 70/30 after a strong equity rally. The manager sells equities and buys bonds to restore targets. This action is called:
- Tax-loss harvesting
- Portfolio rebalancing (Correct answer)
- Tactical tilting
- Opportunistic hedging
Correct answer: Portfolio rebalancing
Rebalancing restores the portfolio to its strategic asset allocation targets after market movements cause drift from intended weights.
Question 2: Which portfolio management concept states that markets price securities efficiently, making consistent alpha generation through active management unlikely?
- Modern portfolio theory
- Efficient market hypothesis (EMH) (Correct answer)
- Capital asset pricing model (CAPM)
- Arbitrage pricing theory (APT)
Correct answer: Efficient market hypothesis (EMH)
The EMH posits that asset prices reflect all available information, leaving little room for active managers to consistently outperform after fees.
Question 3: When constructing a fixed income portfolio, 'duration matching' is used to hedge against which primary risk?
- Credit default risk
- Interest rate (price) risk (Correct answer)
- Reinvestment rate risk only
- Currency risk
Correct answer: Interest rate (price) risk
Duration matching aligns the portfolio's interest rate sensitivity with that of its liabilities, neutralizing the impact of parallel yield curve shifts on portfolio value.
Question 4: Which behavioral bias causes investors to hold losing positions too long and sell winning positions too early, contrary to optimal tax and return strategies?
- Overconfidence bias
- Disposition effect (Correct answer)
- Anchoring bias
- Recency bias
Correct answer: Disposition effect
The disposition effect, rooted in prospect theory, leads investors to realize gains quickly (winners) while avoiding realizing losses (losers).
Question 5: A portfolio's beta is 1.3 relative to the S&P 500. If the market rises 10%, what is the expected portfolio return (assuming zero alpha)?
- 10%
- 13% (Correct answer)
- 7.7%
- 16%
Correct answer: 13%
Expected return = beta × market return = 1.3 × 10% = 13%, as a beta above 1.0 amplifies market movements.
Question 6: In the context of global asset allocation, currency hedging of international equity exposure primarily eliminates which risk?
- Country political risk
- Foreign exchange rate fluctuation risk (Correct answer)
- Emerging market liquidity risk
- Correlation instability risk
Correct answer: Foreign exchange rate fluctuation risk
Currency hedging using forward contracts or currency swaps removes the impact of exchange rate movements on international investment returns.
Question 7: Which asset allocation approach uses scenario analysis and stress testing to evaluate how a portfolio performs during market crises, rather than relying solely on historical correlations?
- Mean-variance optimization
- Black-Litterman model
- Risk parity allocation
- Stress-test-based portfolio construction (Correct answer)
Correct answer: Stress-test-based portfolio construction
Stress-test-based approaches simulate extreme market scenarios (e.g., 2008 crisis, 1987 crash) to assess portfolio vulnerability beyond what normal-distribution models capture.
AIP Portfolio Management & Asset Allocation 4
A 60/40 equity/bond portfolio drifts to 70/30 after a strong equity rally.
The manager sells equities and buys bonds to restore targets.
This action is called: