CFA Level I Portfolio Management Practice Questions

Correct answer: C. 2.0

Rearranging CAPM, β = (E(r) − Rf) / (Rm − Rf) = (21% − 5%) / (13% − 5%) = 16% / 8% = 2.0. Choice D (2.6) results from the common error of dividing the full expected return by the market risk premium without first subtracting the risk-free rate from the numerator (21% / 8% ≈ 2.6). Choice B (1.6) results from an incorrect denominator (e.g., mistakenly using 10% as the premium). Choice A (1.0) would only be correct if the stock's required return simply equaled the market's return, which it does not here.

• A. Beta of 1.0 would imply a required return equal to the market's own 13%, not the 21% given in the problem.
• B. Beta of 1.6 solves to a required return of 5% + 1.6 x 8% = 17.8%, not the 21% specified.
• C. Required return = Rf + beta(Rm-Rf) means 21% = 5% + beta(13%-5%), so 16% = beta x 8%, giving beta = 2.0.
• D. Beta of 2.6 solves to a required return of 5% + 2.6 x 8% = 25.8%, overshooting the 21% given.

• Source: CFA Institute refresher reading: Portfolio Risk and Return: Part II

Correct answer: B. 0.60.

The information ratio is active return divided by tracking error: 3.6% / 6.0% = 0.60. Unlike the Sharpe ratio, it measures return relative to a chosen benchmark per unit of active risk.

• A. This divides the wrong quantities (about 0.6 over 3.6) rather than active return over tracking error.
• B. 3.6% / 6.0% = 0.60.
• C. This inverts the ratio (6.0 / 3.6).
• D. This adds active return and tracking error instead of dividing.

Correct answer: C. 7.2% and 9.0%

The expected return is the weighted average: 0.6 x 10% + 0.4 x 3% = 7.2%. The risk-free asset has zero standard deviation and zero covariance with the market, so portfolio risk is the risky weight times the market's standard deviation: 0.6 x 15% = 9.0%.

• A. This reverses the weights (40% market, 60% risk-free).
• B. This leaves the standard deviation at the market's 15%, ignoring the 40% risk-free holding.
• C. Correct: return 7.2%, standard deviation 9.0%.
• D. This treats the risk-free asset as having a 3% standard deviation, which it does not.

Correct answer: A. The set of portfolios offering the highest expected return for each level of risk (or lowest risk for each level of expected return)

The efficient frontier is the curve of optimal portfolios that maximize expected return for each level of risk, or equivalently minimize risk for each level of expected return, formed from the full set of risky assets. Choice B describes a single specific point (the tangency portfolio), which is related to but not the same as the entire frontier. Choice C describes the capital allocation line/capital market line, which is a distinct concept built once a risk-free asset is introduced. Choice D describes the full feasible set of portfolios, most of which are inefficient and lie inside (not on) the frontier.

• A. The efficient frontier is the set of portfolios that maximize expected return for each risk level (or minimize risk for each return level) — the boundary of non-dominated, efficient portfolios.
• B. The single maximum-Sharpe-ratio portfolio is the tangency portfolio, one specific point on the frontier, not the entire efficient frontier itself.
• C. A line connecting the risk-free asset to the market portfolio describes the Capital Market Line, a distinct though related concept from the efficient frontier of risky assets.
• D. The full set of all possible portfolios, the feasible or attainable set, includes inefficient combinations; the efficient frontier is specifically the dominant subset of that larger set.