IFC - Investment Funds in Canada Constructing Investment Portfolios Questions and Answers

Question 1

A 25-year-old investor with a high risk tolerance and a 40-year time horizon for retirement is constructing their first portfolio. Which of the following asset allocations would be MOST suitable for their primary long-term goal?

Accepted Answer

90% Equity, 10% Fixed Income

Answer

A young investor with a long time horizon (40 years) and a high tolerance for risk can afford to take on more market volatility in exchange for potentially higher long-term returns. An asset mix heavily weighted towards equities is appropriate for a growth-oriented objective.

Question 2

An investor's portfolio has a target asset mix of 60% equities and 40% bonds. Due to strong market performance, the equity portion has grown to represent 75% of the portfolio's value. Which of the following actions describes the process of rebalancing?

Accepted Answer

Selling a portion of the equity holdings and using the proceeds to buy bonds.

Answer

Rebalancing is the process of realigning the weightings of a portfolio's assets. This involves selling asset classes that have grown beyond their target allocation and buying those that are underweight to restore the portfolio to its original strategic asset mix.

Question 3

Which of the following risks can be significantly mitigated through proper diversification of a portfolio across various asset classes, industries, and geographic regions?

Accepted Answer

Unsystematic risk

Answer

Unsystematic risk, also known as diversifiable or specific risk, is the risk inherent to a specific company or industry. It can be significantly reduced by combining a variety of assets in a portfolio. Systematic risk (e.g., interest rate risk, inflation risk) affects the entire market and cannot be eliminated through diversification.

Question 4

Which of the following statements best describes strategic asset allocation?

Accepted Answer

It is the process of establishing a long-term, target asset mix based on a client's objectives and risk tolerance.

Answer

Strategic asset allocation is the foundational, long-term plan for a portfolio. It involves setting target allocations for various asset classes based on the investor's specific goals, risk tolerance, and time horizon, and it is maintained through periodic rebalancing.

Question 5

What is the primary objective of adding assets with low or negative correlation to each other within an investment portfolio?

Accepted Answer

To reduce the portfolio's overall volatility.

Answer

The core principle of diversification is that by combining assets that do not move in the same direction at the same time (i.e., have low or negative correlation), the overall ups and downs of the portfolio can be smoothed out. This reduces the portfolio's standard deviation, or volatility.

IFC - Investment Funds in Canada Practice Test

IFC - Investment Funds in Canada Practice Test

IFC - Investment Funds in Canada Constructing Investment Portfolios Questions and Answers