Mixed Deck — All CPM Topics Flashcards

A portfolio manager benchmarked to the Bloomberg U.S. Aggregate Bond Index takes a significant underweight in government bonds and overweight in corporate bonds. This represents:

Answer: An active credit sector rotation bet

Deviating meaningfully from benchmark sector weights (underweighting governments, overweighting corporates) is an active sector rotation strategy driven by a view on relative value.

Which of the following is the primary benefit of international diversification?

Answer: Reduction of portfolio risk by including assets with low correlation to domestic holdings

International diversification reduces total portfolio risk when foreign assets have low correlations with domestic assets, though it does introduce currency and geopolitical risks.

A portfolio manager uses stress testing to assess portfolio risk. Stress testing differs from standard VaR because it:

Answer: Evaluates portfolio behavior under extreme, hypothetical scenarios beyond historical data

Stress testing examines how a portfolio performs under severe, often hypothetical scenarios (e.g., a 2008-style crisis) that may not be captured by historical VaR calculations.

Which document should clearly outline client rights and manager responsibilities?

Answer: Investment management agreement

The Investment Management Agreement (IMA) is a legally binding document that formally establishes the relationship between a client and a portfolio manager. It clearly outlines the scope of services, investment objectives, fees, client rights, and the manager's responsibilities, ensuring transparency and mutual understanding.

A portfolio manager notices that a fund's returns correlate strongly with a broad market index during downturns but diverge during upturns. This best describes which type of risk?

Answer: Downside correlation risk

Downside correlation risk refers to the tendency of assets to become more correlated during market downturns, reducing diversification benefits precisely when they are most needed.

Rebalancing a portfolio to its strategic asset allocation targets serves to:

Answer: Maintain the desired risk profile and systematically buy low/sell high

Rebalancing restores the original risk/return profile and has the side effect of systematically trimming outperformers (selling high) and adding to underperformers (buying low).

Duration is primarily used in fixed income portfolio management to measure:

Answer: A bond's price sensitivity to changes in interest rates

Duration quantifies the approximate percentage change in a bond's price for a 1% change in interest rates, making it the primary measure of interest rate risk.

Which performance measure isolates a manager’s skill at generating returns independent of market movements?

Answer: Alpha

Alpha is a performance measure that quantifies the excess return of a portfolio or investment compared to its benchmark, after adjusting for market risk (beta). It represents the value added by a portfolio manager's skill in security selection and market timing. A positive alpha indicates that the manager has outperformed the market on a risk-adjusted basis.

Which measure is commonly used to assess the risk-adjusted return of a portfolio?

Answer: Sharpe Ratio

The Sharpe Ratio is a widely used metric to evaluate the risk-adjusted return of an investment portfolio. It measures the excess return (return above the risk-free rate) generated by the portfolio for each unit of total risk taken, where total risk is represented by the standard deviation of returns. A higher Sharpe Ratio indicates better risk-adjusted performance.

Which equity valuation multiple compares stock price to earnings per share and is most widely used by analysts?

Answer: Price-to-earnings (P/E)

The price-to-earnings (P/E) ratio is the most widely used equity valuation multiple, comparing a stock's current price to its earnings per share to assess relative value.

Which hedging strategy involves selling call options on securities already held in the portfolio?

Answer: Covered call

A covered call strategy involves selling call options on securities already owned, generating premium income while capping upside potential.

Which portfolio construction technique allocates assets based on risk contribution rather than dollar value?

Answer: Risk parity

Risk parity allocates portfolio weights so that each asset class contributes equally to total portfolio risk, often using leverage to boost lower-volatility assets.

What does standard deviation represent in portfolio performance?

Answer: Volatility of returns around the mean

Standard deviation represents the volatility of returns around the mean, serving as a common measure of risk in finance. It quantifies the dispersion of an investment's historical returns, indicating how much the returns typically deviate from their average. A higher standard deviation implies greater price fluctuations and thus higher risk.

Which section of an IPS details how often portfolio performance should be reviewed?

Answer: Monitoring and review policy

The monitoring and review policy section of an IPS details how often the portfolio's performance, asset allocation, and adherence to the IPS guidelines should be evaluated. This section ensures that the investment strategy remains appropriate and effective over time. Regular reviews help to identify any necessary adjustments due to market changes or evolving client circumstances.

Which asset class is typically considered the most liquid and lowest risk in a portfolio?

Answer: Cash and cash equivalents

Cash and cash equivalents (e.g., Treasury bills, money market funds) offer the highest liquidity and lowest risk, though they also provide the lowest long-term returns.

A portfolio manager's active share measures:

Answer: The percentage of portfolio holdings that differ from the benchmark, indicating the degree of active management

Active share quantifies how different a portfolio's holdings are from its benchmark; a high active share indicates meaningful active bets, while a low active share suggests benchmark-hugging.

Which metric combines both return and risk into a single measure by dividing excess return by the portfolio's standard deviation?

Answer: Sharpe ratio

The Sharpe ratio measures risk-adjusted return by dividing a portfolio's excess return (above the risk-free rate) by its standard deviation of returns.

Which of the following best describes a floating rate note (FRN)?

Answer: A bond whose coupon resets periodically based on a reference rate (e.g., SOFR), reducing interest rate risk

Floating rate notes have variable coupon payments tied to a benchmark rate, so their prices are relatively stable when interest rates change, providing low interest rate risk.

An equity portfolio manager with a concentrated portfolio of 20 stocks primarily faces which type of risk compared to a diversified 200-stock portfolio?

Answer: Higher idiosyncratic (stock-specific) risk

A concentrated portfolio retains significant idiosyncratic risk because fewer holdings means individual stock-specific events can have a major impact on portfolio returns.

Why is confidentiality important in portfolio management?

Answer: To protect sensitive client information

Confidentiality is paramount in portfolio management because clients share highly sensitive personal and financial information. Protecting this information is essential to maintaining trust, preventing misuse, and complying with privacy regulations. Breaching confidentiality can lead to financial harm for the client and severe reputational damage for the manager.