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CFA Level III study materials
CFA Level III study resources

CFA Level III practice questions

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Question 1Ethical and Professional Standards

According to the CFA Institute Code of Ethics, members and candidates must:

  1. Report all personal trades to the regulator before execution
  2. Guarantee that client portfolios will not suffer losses
  3. Avoid holding any securities in a personal account
  4. Act with integrity, competence, diligence, and respect Correct answer.

Explanation

The Code of Ethics requires members to act with integrity, competence, diligence, and respect, and to place the integrity of the profession and the interests of clients above their own. It sets ethical principles of conduct, not promises about investment outcomes.

Question 2Ethical and Professional Standards

A member works in a country where local law permits a practice that the CFA Institute Standards prohibit. The member should:

  1. Resign from the firm until the conflict is resolved
  2. Ask CFA Institute for an exemption from the Standards
  3. Follow the applicable local law in all cases
  4. Follow the stricter requirement Correct answer.

Explanation

Standard I(A) requires members to comply with the most strict of applicable law, the Code, and the Standards. Local law operates as a floor rather than a ceiling, so where it is less strict than the Standards, the Standards govern.

Question 3Ethical and Professional Standards

Under Standard I(B) Independence and Objectivity, which statement best describes gifts received by an analyst from a company she covers?

  1. Gifts are acceptable as long as they are disclosed to the client in writing
  2. Gifts below a fixed dollar threshold set by the firm are always acceptable
  3. Gifts that could compromise independence must not be accepted Correct answer.
  4. Any gift, regardless of value, is prohibited

Explanation

Members must not accept gifts or benefits that could reasonably be expected to impair their independence and objectivity, and should decline or disclose borderline items. Disclosure is expected practice but does not by itself cure a conflict that compromises objectivity.

Question 4Ethical and Professional Standards

Under the mosaic theory, a member may reach an investment conclusion by:

  1. Trading on material nonpublic information obtained without illegality
  2. Sharing material nonpublic information with clients who will trade on it
  3. Combining public and nonmaterial nonpublic information Correct answer.
  4. Using material nonpublic information after notifying compliance

Explanation

The mosaic theory permits members to act on conclusions assembled from public information combined with nonmaterial nonpublic information. Material nonpublic information may never be used or passed along, regardless of how it was obtained.

Question 5Ethical and Professional Standards

A member managing a client's portfolio under a fiduciary duty must act by:

  1. Maximizing the firm's fee revenue from the account
  2. Placing the client's interests first Correct answer.
  3. Matching the benchmark's return every year
  4. Guaranteeing the client against investment losses

Explanation

Standard III(A) requires members to act for the benefit of clients and to place client interests ahead of their own and their firm's. The duty is one of loyalty, prudence, and care, not an assurance of results.

Question 6Ethical and Professional Standards

A member plans to accept a paid board seat at a company whose business competes with her employer's. Under Standard IV(B) Additional Compensation Arrangements, she must:

  1. Obtain written consent from the employer before accepting Correct answer.
  2. Disclose the seat to clients but not to her employer
  3. Notify the employer within 30 days after accepting the seat
  4. Disclose the arrangement only to affected clients

Explanation

Standard IV(B) requires written consent from the employer before a member accepts compensation that competes with, or creates a conflict with, the employer's interests. After-the-fact notification does not satisfy the requirement.

Question 7Ethical and Professional Standards

Before using third-party research as a basis for a recommendation, a member must:

  1. Confirm that the provider is a registered investment adviser
  2. Pay a market fee for the research to avoid a conflict
  3. Obtain approval from the firm's compliance department
  4. Determine the research has a reasonable basis Correct answer.

Explanation

Standard V(A) Diligence and Reasonable Basis requires members to review research and satisfy themselves that it has a reasonable and adequate basis. Reliance on another party's work is permitted only after such review.

Question 8Ethical and Professional Standards

Under the GIPS Standards, a firm claiming compliance must include in each composite:

  1. All discretionary and non-discretionary portfolios held by the firm
  2. Only portfolios that outperformed the composite benchmark
  3. All actual, fee-paying, discretionary portfolios Correct answer.
  4. Only non-fee-paying portfolios managed for employees

Explanation

Composites must include every actual, fee-paying, discretionary portfolio that meets the composite definition. Non-discretionary portfolios and non-fee-paying portfolios are excluded, though non-fee-paying discretionary portfolios may be included if the firm discloses their presence.

Question 9Ethical and Professional Standards

An oversubscribed new issue is being allocated among the firm's client accounts. The member responsible should:

  1. Give priority to the firm's largest fee-paying clients
  2. Allocate only to clients who trade frequently
  3. Favor accounts controlled by the member's family
  4. Allocate shares fairly among eligible accounts Correct answer.

Explanation

Standard III(B) Fair Dealing requires an objective allocation process that does not advantage one client over another. Preferential treatment based on account size, family ties, or trading volume breaches the duty of fair dealing.

Question 10Ethical and Professional Standards

A client instructs her adviser to buy a security that the adviser believes is unsuitable for her objectives. The adviser should:

  1. Execute after telling the client the trade is unsuitable Correct answer.
  2. Refuse to execute the trade under any circumstances
  3. Obtain written approval from compliance before executing
  4. Reduce the advisory fee on the account going forward

Explanation

Under Standard III(C) Suitability, a client's unsolicited instruction may be executed once the member has explained the suitability concerns and documented the client's decision. The member is not obliged to refuse, and internal approval is not the governing requirement.

Question 11Ethical and Professional Standards

A member who recently joined a new firm wants to show prospective clients performance she achieved at her prior employer. Under Standard III(D) Performance Presentation, she may:

  1. Present it only with the prior employer's written consent
  2. Present it clearly labeled as prior-firm performance Correct answer.
  3. Never present performance achieved at another firm
  4. Present it as the current firm's own track record

Explanation

A member may present a record achieved elsewhere provided it is not misleading, which requires disclosure that the performance was earned at another firm. Presenting it as the new firm's record misstates the source of the results.

Question 12Ethical and Professional Standards

A member receives a court order requiring him to disclose confidential client information. He should:

  1. Inform all clients that information has been requested
  2. Comply with the court order Correct answer.
  3. Refuse, because client confidentiality is absolute
  4. Disclose only after obtaining the client's consent

Explanation

Standard III(E) requires members to keep client information confidential except when disclosure is required by law or concerns illegal activity. A valid legal compulsion overrides the duty of confidentiality.

Question 13Ethical and Professional Standards

A member intends to resign and start her own firm. Before resigning, she may:

  1. Solicit the employer's clients to move with her
  2. Use confidential employer data to value the new business
  3. Arrange financing and office space for a new firm Correct answer.
  4. Copy the employer's client list for later use

Explanation

Standard IV(A) permits preparation to compete, such as securing financing and premises, while the member is still employed. Soliciting clients, taking records, or using confidential information before resignation breaches the duty of loyalty to the employer.

Question 14Ethical and Professional Standards

A supervisor learns that a member of her team has violated firm policy. Under Standard IV(C) Responsibilities of Supervisors, she should first:

  1. Report the matter only at the annual compliance review
  2. Stop the violation and prevent its recurrence Correct answer.
  3. Resign from the firm immediately
  4. Wait for the compliance department to act

Explanation

Supervisors must take reasonable steps to detect and prevent violations; once aware of one, they must act promptly to halt it and prevent repetition, escalating as necessary. Passive monitoring or deferral to a scheduled review is inadequate.

Question 15Ethical and Professional Standards

A member changes the analytical model behind his recommendations, and the change materially alters the risk profile of the securities he recommends. Under Standard V(B) Communication with Clients, he must:

  1. Wait until the next annual review to explain it
  2. Disclose the change to clients promptly Correct answer.
  3. Disclose it only if a client asks about the model
  4. Apply the old method for one more quarter

Explanation

Standard V(B) requires members to disclose the basic process used and any changes that may significantly affect that process. Because the model change affects risk, clients should be informed promptly rather than at a scheduled review.

Question 16Ethical and Professional Standards

Under Standard V(C) Record Retention, members should retain records supporting their investment analyses and recommendations for:

  1. At least seven years Correct answer.
  2. At least one year
  3. Until the client relationship ends
  4. At least three years

Explanation

The Standards recommend retaining records that support investment analysis, recommendations, and actions for at least seven years, unless a stricter local requirement applies. Retention should be in a form that allows reconstruction of the analysis.

Question 17Ethical and Professional Standards

An analyst is asked to join the board of directors of a company she covers. Under Standard VI(A) Disclosure of Conflicts, she must:

  1. Disclose it to her employer and in research reports Correct answer.
  2. Disclose it only after the annual report is published
  3. Accept only if the compensation is below a set limit
  4. Decline, because board seats are always prohibited

Explanation

Board service creates a conflict with the analyst's obligation to produce objective research, so it must be disclosed to the employer and to clients or readers of the research. Some firms prohibit such service, but the Standards require timely disclosure either way.

Question 18Ethical and Professional Standards

A member controls an investment account for his adult son. For purposes of Standard VI(B) Priority of Transactions, this account should be treated as:

  1. A proprietary account of the firm
  2. A regular client account with no special treatment
  3. An institutional account of the firm
  4. The member's own account for priority purposes Correct answer.

Explanation

Accounts in which the member has a beneficial interest, or over which he exercises investment control, are treated as personal accounts for priority purposes. Client accounts must be traded before such accounts.

Question 19Ethical and Professional Standards

A member agrees to pay an accountant a fee for each client the accountant refers to her. Under Standard VI(C) Referral Fees, the member must:

  1. Disclose it only after the client signs an agreement
  2. Keep it private to protect client information
  3. Disclose it to her employer and to referred clients Correct answer.
  4. Disclose it to her employer only

Explanation

Referral arrangements must be disclosed to the employer and to clients and prospects, including the nature of the compensation, so that clients can judge the arrangement. Confidentiality of client data does not justify concealing the fee.

Question 20Ethical and Professional Standards

Standard VII Misconduct applies to:

  1. Any conduct that reflects adversely on the profession Correct answer.
  2. Only conduct that occurs during business hours
  3. Only conduct that involves the member's clients
  4. Only conduct that has resulted in a criminal conviction or fine

Explanation

The Misconduct Standard covers conduct in professional and personal life that could reflect adversely on the member's honesty, integrity, or competence, or on the profession's reputation. A criminal conviction is not a prerequisite.

Question 21Ethical and Professional Standards

A member submits large buy orders shortly before the close solely to raise the closing price of a thinly traded stock he already owns. This conduct most likely violates:

  1. Standard II(B) Market Manipulation Correct answer.
  2. Standard IV(A) Loyalty to Employer
  3. Standard III(A) Loyalty, Prudence, and Care
  4. Standard V(B) Communication with Clients

Explanation

Transactions intended to distort prices, or to mislead participants about supply and demand, constitute price manipulation under Standard II(B). That the orders are genuine and executed does not cure the manipulative purpose.

Question 22Ethical and Professional Standards

A firm narrows the definition of an existing composite. Under the GIPS Standards, the firm must:

  1. Create a new composite and stop reporting the old one
  2. Apply the new definition retroactively to all history
  3. Not apply it retroactively and disclose the change Correct answer.
  4. Remove non-qualifying portfolios from the historical record

Explanation

Changes to a composite definition must not be applied retroactively, and the firm must disclose the change and its effective date so the presentation is not misleading. Rewriting prior history would misrepresent the composite's record.

Question 23Ethical and Professional Standards

A member may use client brokerage commissions to obtain third-party research when:

  1. When the research benefits the accounts that generated the commissions Correct answer.
  2. Whenever the research supports the firm's overall investment process, regardless of which accounts pay
  3. Only when the research is produced internally by the member's firm
  4. Only when the client has approved the specific broker in writing

Explanation

Client brokerage is a client asset, so directed commissions must purchase research that benefits the accounts paying them, and execution must remain competitive. Research that benefits only other clients amounts to a misappropriation of client assets.

Question 24Ethical and Professional Standards

A member discovers that her employer's trading practices violate securities law, and her supervisor refuses to change them. If she has no authority to stop the conduct, she should:

  1. Take no action if legal counsel approved the practice
  2. Dissociate from the activity Correct answer.
  3. Continue the practice because she did not design it
  4. Report the practice to clients and keep working

Explanation

Standard I(A) requires members to dissociate from illegal or unethical activity that they cannot stop, which may extend to resigning. Continuing to participate in or benefit from the conduct is itself a violation.

Question 25Ethical and Professional Standards

During a paid consultation call, an industry expert reveals confidential details of his employer's unreleased earnings. The member should:

  1. Stop the call, avoid trading, and contact compliance Correct answer.
  2. Use the information because it came from a paid consultant
  3. Trade only in the consultant's employer's competitors
  4. Share it with clients so they can decide

Explanation

The disclosure is material and nonpublic, so it may not be used or communicated; trading in related securities such as competitors can also misuse it. The member should end the discussion and notify compliance.

Question 26Ethical and Professional Standards

A member manages a large pension account. The client, pleased with recent results, offers her an expensive watch as a token of appreciation. Under Standard I(B) Independence and Objectivity, the member should most appropriately:

  1. Disclose the gift to her employer before deciding whether to accept it. Correct answer.
  2. Return the gift only if its value exceeds a limit set by the securities regulator.
  3. Accept the gift, because gifts offered by clients never raise independence concerns.
  4. Accept the gift but recuse herself from the next review of that client's account.

Explanation

Standard I(B) requires members to use reasonable care to avoid gifts or benefits that could compromise their independence and objectivity. The practical requirement is to inform the employer so that it, not the member alone, judges whether the benefit creates a threat. Recusal or external legal thresholds do not substitute for this disclosure obligation.

Question 27Ethical and Professional Standards

A member preparing a research report copies a paragraph of analysis from a competitor's published report and inserts it, unchanged and without a citation, into her own report. Her conduct most likely:

  1. Is acceptable if she later adds a general bibliography covering the industry.
  2. Violates Standard I(C) Misrepresentation, which requires attributing the work of others. Correct answer.
  3. Violates Standard I(C) only if the competitor's report was distributed to the public.
  4. Is acceptable, because published research reports are not protected by copyright.

Explanation

Standard I(C) prohibits plagiarism, which includes presenting another person's analysis or ideas as one's own. Attribution is required whether the borrowed material is quoted verbatim or paraphrased, and public distribution of the source does not remove the obligation.

Question 28Ethical and Professional Standards

A member with proxy-voting authority over client shares receives a proxy for a contested merger vote. Under Standard III(A) Loyalty, Prudence, and Care, the member should:

  1. Vote each proxy in the best economic interest of the client. Correct answer.
  2. Vote the shares in favor of management's recommendation to preserve the client relationship.
  3. Sell the shares whenever a proxy contest arises so that no vote is required.
  4. Delegate the voting decision to the client's custodian bank.

Explanation

Standard III(A) treats proxies as client assets with economic value, so they must be voted in the client's best interest, weighing the costs and benefits of voting. Delegation to a custodian or a default in favor of management does not discharge that duty, and the firm should have a documented proxy policy.

Question 29Ethical and Professional Standards

A member buys store-traffic data from a consultant who is authorized to sell it; the data is nonpublic but not material. She combines it with public filings to forecast a retailer's sales. Her use of the data is:

  1. Permissible only if the consultant's data covers the most recent completed quarter.
  2. Permissible only if the member discloses the consultant's identity in her report.
  3. Permissible, because combining nonmaterial nonpublic data with public data is allowed. Correct answer.
  4. Impermissible, because it relies on information that has not been disclosed by the retailer.

Explanation

Under the mosaic theory, a member may act on a conclusion formed from public information plus nonmaterial nonpublic information obtained without a breach of duty. Only material nonpublic information, or information obtained through a breach of duty, triggers the trading and disclosure restrictions of Standard II(A).

Question 30Ethical and Professional Standards

In a published research report, a member writes that a company "will double its dividend next year" without labeling the statement as a forecast. Under Standard V(B) Communication with Clients and Prospective Clients, this is:

  1. A violation, because members must distinguish fact from opinion in communications. Correct answer.
  2. A violation, because members may not publish forecasts of corporate actions.
  3. Permitted, because dividend policy is already publicly available information.
  4. Permitted, because the forecast is based on analysis the member believes is reasonable.

Explanation

Standard V(B) requires members to separate fact from opinion when communicating investment recommendations and analyses. A forward-looking projection presented as though it were an established fact misleads clients regardless of how sound the underlying analysis may be.

Question 31Ethical and Professional Standards

An advisory client terminates her relationship with a member's firm and transfers her account to another firm. With respect to the client's personal and portfolio information, the member should:

  1. Disclose the client's identity during an interview with a prospective employer.
  2. Share the client's portfolio details with colleagues who handle similar accounts.
  3. Continue to treat the information as confidential after the relationship ends. Correct answer.
  4. Provide the client's records to the new adviser in response to an oral request.

Explanation

Standard III(E) Preservation of Confidentiality survives the end of the client relationship, so former clients' information remains protected. Disclosure is permitted only with the client's consent, when required by law, or when the information concerns illegal activity by the client.

Question 32Ethical and Professional Standards

With respect to verification under the GIPS Standards, which statement is most accurate?

  1. Verification is voluntary and is performed by an independent third party. Correct answer.
  2. Verification must be completed annually before a firm may claim compliance.
  3. Verification is required only for composites that contain non-discretionary assets.
  4. Verification may be performed by the firm's own compliance staff if it is documented.

Explanation

Verification is a voluntary, firm-wide review conducted by an independent third party; a firm may claim compliance without being verified. Firms that choose verification must ensure the verifier is independent of the firm and of the composite construction and performance calculation process.

Question 33Ethical and Professional Standards

An analyst initiates coverage of a company in which she owns shares that she inherited from a relative. Under Standard VI(A) Disclosure of Conflicts, she should most appropriately:

  1. Publish the report without disclosure, because the shares were inherited rather than purchased.
  2. Transfer the shares to a family member who is not involved in her coverage.
  3. Sell the shares before publishing, because ownership impairs objectivity.
  4. Disclose the ownership to her employer and to clients in the research report. Correct answer.

Explanation

Standard VI(A) requires members to disclose to their employer, clients, and prospective clients all matters that could reasonably be expected to impair their independence and objectivity, including a direct ownership interest in a covered company. Disclosure allows the audience to judge the recommendation; the ownership itself does not bar publication.

Question 34Ethical and Professional Standards

A firm acquires another investment manager and wants to present the acquired manager's composite performance as its own. Under the GIPS Standards, the acquiring firm may present that track record:

  1. In all cases, because the acquired firm ceases to exist as a separate entity.
  2. Only if the responsible personnel and the supporting records are acquired. Correct answer.
  3. Only after the acquired composites have been verified for the entire period.
  4. Never, because performance belongs permanently to the firm that achieved it.

Explanation

The GIPS Standards permit portability of investment results when the acquiring firm also acquires the investment decision makers responsible for the record and the records supporting it. If the personnel or records are not acquired, the historical performance cannot be presented as the new firm's own.

Question 35Asset Allocation

Which set of inputs is required to construct a mean-variance efficient frontier?

  1. Expected returns and historical prices only
  2. The risk-free rate and the rate of inflation only
  3. Earnings growth rates and dividend yields
  4. Expected returns, variances, and correlations Correct answer.

Explanation

Mean-variance optimization requires an expected return for each asset, a variance for each asset, and pairwise correlations or covariances. These inputs define the portfolio return and risk trade-off used to trace the efficient frontier.

Question 36Asset Allocation

Tactical asset allocation is best described as:

  1. Setting weights to match a broad market benchmark
  2. Short-term deviations from policy weights based on market views Correct answer.
  3. Rebalancing back to policy weights after market drift
  4. The long-term policy portfolio set from objectives and constraints

Explanation

Tactical asset allocation deliberately deviates from strategic policy weights to exploit short-term opportunities or views. It is distinguished from strategic allocation, which sets the long-run policy mix.

Question 37Asset Allocation

A calendar rebalancing strategy is characterized by:

  1. Rebalancing only when the portfolio's tax status changes
  2. Rebalancing continuously so weights never drift
  3. Rebalancing at fixed time intervals Correct answer.
  4. Rebalancing whenever a weight moves outside a preset band

Explanation

Calendar rebalancing occurs at predetermined dates, such as monthly, quarterly, or annually, regardless of the size of weight drift. Threshold rebalancing, by contrast, is triggered by deviations outside a band.

Question 38Asset Allocation

In a risk budgeting framework, the primary allocation decision concerns:

  1. Setting weights so each asset has an equal expected return contribution
  2. Allocating total portfolio risk among assets or managers Correct answer.
  3. Maximizing expected return subject to a maximum Sharpe ratio
  4. Allocating capital equally across asset classes

Explanation

Risk budgeting focuses on how much of the portfolio's total risk is contributed by each asset, strategy, or manager. Capital weights are a means to achieve the desired risk allocation, not the objective itself.

Question 39Asset Allocation

A common behavioral explanation for home bias in asset allocation is:

  1. Regulators require full domestic holdings
  2. Familiarity and lower perceived information costs Correct answer.
  3. Domestic assets always offer higher expected returns
  4. Foreign assets cannot be hedged in currency markets

Explanation

Investors often favor domestic securities because they feel more familiar with local companies and perceive lower information and monitoring costs. This familiarity bias can reduce diversification even when foreign assets offer attractive risk-adjusted returns.

Question 40Asset Allocation

A key advantage of Monte Carlo simulation in asset allocation is that it:

  1. Guarantees the highest expected return
  2. Eliminates estimation error in expected returns
  3. Requires no assumptions about return distributions
  4. Can model path-dependent goals and non-normal returns Correct answer.

Explanation

Monte Carlo simulation generates many possible paths for returns, allowing the analysis of path-dependent goals and return distributions that need not be normal. It does not eliminate input or estimation error.

Question 41Asset Allocation

For a short-horizon investor with low risk tolerance who holds foreign equities, fully hedging currency exposure most likely will:

  1. Have no effect on portfolio risk
  2. Eliminate all foreign equity risk
  3. Reduce the volatility of domestic-currency returns Correct answer.
  4. Increase expected return and increase volatility

Explanation

Hedging foreign currency exposure removes currency fluctuations from the investor's domestic-currency return, which generally reduces return volatility over short horizons. It does not remove the underlying equity market risk.

Question 42Asset Allocation

In asset allocation, a liquidity constraint most directly limits:

  1. The choice between active and passive management
  2. The expected return forecast for public equities
  3. The maximum weight in illiquid assets Correct answer.
  4. The correlation between asset classes

Explanation

Liquidity constraints determine how much of a portfolio can be committed to assets that cannot be sold quickly without a price concession. This directly caps allocations to private equity, real estate, and other illiquid investments.

Question 43Asset Allocation

The Black-Litterman model produces expected returns by combining:

  1. Factor exposures with risk budgets
  2. Equilibrium expected returns with investor views Correct answer.
  3. Historical returns with Monte Carlo paths
  4. Liability durations with asset durations

Explanation

Black-Litterman starts with equilibrium returns implied by market capitalization weights and updates them with the investor's subjective views. The confidence placed in each view influences how far the posterior returns move from equilibrium.

Question 44Asset Allocation

In surplus optimization for a pension plan, the objective is typically to maximize:

  1. Expected surplus return relative to surplus risk Correct answer.
  2. Total assets relative to a market index
  3. The funded ratio regardless of risk
  4. The return on the growth portfolio only

Explanation

Surplus optimization treats the difference between assets and liabilities as the relevant portfolio and seeks an attractive trade-off between expected surplus return and surplus risk. This aligns asset allocation with the plan's liability obligations.

Question 45Asset Allocation

Resampling is used in mean-variance optimization primarily to:

  1. Increase expected returns of the optimized portfolio
  2. Reduce sensitivity of optimal weights to estimation error Correct answer.
  3. Guarantee out-of-sample outperformance
  4. Remove the need for covariance estimates

Explanation

Resampling repeatedly draws from the distribution of the inputs and averages the resulting optimal portfolios. This smooths the weights and reduces the tendency of mean-variance optimization to concentrate in assets with favorable estimation error.

Question 46Asset Allocation

During the early expansion phase of a business cycle, which asset tilt is most consistent with a cyclical asset allocation approach?

  1. Cash equivalents
  2. Long-duration government bonds
  3. Defensive consumer staples equities
  4. Cyclical equities and credit-sensitive bonds Correct answer.

Explanation

Early expansion typically favors assets sensitive to economic growth, such as cyclical equities and lower-quality credit. Defensive assets tend to be more attractive in later, slowing phases of the cycle.

Question 47Asset Allocation

A risk parity portfolio is constructed so that:

  1. The portfolio has zero correlation across assets
  2. Each asset has an equal capital weight
  3. Each asset has an equal expected return contribution
  4. Each asset contributes equally to total portfolio risk Correct answer.

Explanation

Risk parity targets equal risk contributions from each asset or strategy rather than equal capital weights. This often results in larger allocations to lower-volatility assets to balance their risk contribution.

Question 48Asset Allocation

In liability-driven investing, a key risk measure for a pension plan is:

  1. The tracking error versus a peer benchmark
  2. The standard deviation of asset returns alone
  3. The beta of the growth portfolio
  4. The volatility of the surplus (assets minus liabilities) Correct answer.

Explanation

Liability-driven investing evaluates risk relative to liabilities, so surplus volatility is central. Asset-only risk measures can miss the interest rate and inflation sensitivities that affect liabilities.

Question 49Asset Allocation

Goals-based asset allocation typically differs from mean-variance optimization by:

  1. Ignoring the probability of achieving goals
  2. Creating sub-portfolios for each goal with different risk levels Correct answer.
  3. Using a single aggregate risk-aversion parameter
  4. Assuming all goals have the same time horizon

Explanation

Goals-based allocation separates wealth into sub-portfolios, each dedicated to a specific goal with its own time horizon and risk capacity. This differs from optimizing one aggregate portfolio with a single risk-aversion parameter.

Question 50Asset Allocation

The strategic asset allocation of a portfolio is primarily determined by:

  1. Short-term market timing signals
  2. Recent performance of asset classes
  3. The plan's peer benchmark group only
  4. Objectives, constraints, and long-run return expectations Correct answer.

Explanation

Strategic asset allocation reflects the investor's long-term objectives and constraints together with long-run capital market expectations. Short-term signals and recent performance belong to tactical decisions, not policy setting.