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Portfolio Diversification Strategies Flashcards

7 cards from real CPT practice questions. Tap to flip, then mark Knew It or Still Learning — missed cards come back until you master them.

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  1. Which metric measures the degree to which two assets move together, ranging from -1 to +1?

    Answer: Correlation coefficient

    The correlation coefficient quantifies the linear relationship between two assets, with -1 indicating perfect negative correlation and +1 indicating perfect positive correlation.

  2. An investor holds only domestic large-cap stocks. Which diversification step would most reduce country-specific risk?

    Answer: Adding international equities

    Adding international equities introduces exposure to different economic cycles and political environments, reducing country-specific (sovereign) risk.

  3. What is the primary purpose of rebalancing a diversified portfolio?

    Answer: To restore the portfolio to its target asset allocation

    Rebalancing restores a portfolio to its intended risk profile after market movements cause asset class weights to drift from targets.

  4. Which portfolio construction approach weights assets inversely to their volatility?

    Answer: Risk parity portfolio

    Risk parity allocates more capital to lower-volatility assets so each asset contributes equally to overall portfolio risk.

  5. An investor adds Treasury bonds to an equity portfolio. The primary diversification benefit comes from bonds':

    Answer: Tendency to appreciate when equities fall sharply

    Treasuries typically exhibit negative or low correlation with equities during market downturns, providing a cushion when stocks decline.

  6. Which of the following best describes 'over-diversification'?

    Answer: Holding so many positions that marginal risk reduction becomes negligible while costs increase

    Over-diversification occurs when adding more holdings provides virtually no additional risk reduction but raises transaction costs and monitoring complexity.

  7. In a portfolio context, 'concentration risk' refers to:

    Answer: Excessive exposure to a single security, sector, or geography

    Concentration risk arises when a portfolio is over-weighted in one area, making its performance heavily dependent on that single source of return.