Series 65 Portfolio Management Practice Questions
Question 1
A client's account return looks much lower than the strategy composite because the client deposited substantial funds just before a market decline. Which measure better isolates the manager's performance from client-controlled external cash-flow timing?
- A. The internal rate of return (money-weighted return), which neutralizes the timing and size of client deposits and withdrawals.
- B. Time-weighted return, using subperiod linking around material cash flows.
- C. The simple change in dollar account balance from the start to the end of the period, adjusted for fees.
- D. The account's current dividend yield, which reflects the manager's skill separate from client cash flows.
Show answer and explanation
Correct answer: B. Time-weighted return, using subperiod linking around material cash flows.
Time-weighted return links subperiod returns and so removes the effect of the timing and size of external cash flows, isolating manager performance. Money-weighted return reflects the investor's own experience.
- A. Money-weighted return is heavily influenced by the timing and size of client cash flows, so it does not isolate the manager.
- B. Correct: time-weighted return neutralizes external cash flow timing.
- C. A change in dollar balance mixes deposits, withdrawals and investment results.
- D. Dividend yield is an income measure and does not measure total manager performance.
Question 2
Combining two assets within a portfolio provides the greatest diversification benefit (risk reduction for a given expected return) when the correlation coefficient between their returns is close to...
- A. +1.0
- B. +0.5
- C. 0
- D. -1.0
Show answer and explanation
Correct answer: D. -1.0
Correlation coefficients range from −1.0 to +1.0. A correlation near −1.0 (perfect negative correlation) means the two assets tend to move in opposite directions, so combining them can substantially reduce overall portfolio volatility for a given level of expected return — the maximum diversification benefit. A correlation near +1.0 means the assets move together and provide little to no diversification benefit; 0 (no correlation) still offers some benefit but less than a strongly negative correlation.
- A. Incorrect — +1.0 correlation means the assets move perfectly together, providing no diversification benefit.
- B. Incorrect — +0.5 is still positively correlated and offers only modest diversification benefit, not the greatest.
- C. Incorrect — 0 correlation offers some diversification benefit but not as much as perfect negative correlation.
- D. Correct — a correlation coefficient near −1.0 provides the maximum diversification benefit, since the assets tend to move in opposite directions.
Question 3
A stock has a beta of 1.6. This best indicates that, relative to the overall market, the stock's:
- A. Total risk, including both systematic and company-specific risk, is 1.6 times the market's, so the stock is 60% more volatile than the market overall
- B. Systematic (market-related) risk is greater than the market's, tending to move about 1.6% for every 1% market move, but this says nothing about the stock's unsystematic risk
- C. Standard deviation of returns is 1.6 times the market's standard deviation, so beta can be used as a direct measure of total volatility
- D. Return will be 1.6 times the market's return in both rising and falling markets, so beta works as a predictor of the stock's realized return
Show answer and explanation
Correct answer: B. Systematic (market-related) risk is greater than the market's, tending to move about 1.6% for every 1% market move, but this says nothing about the stock's unsystematic risk
Beta measures sensitivity to systematic (market/non-diversifiable) risk only — a beta of 1.6 suggests the stock tends to move about 1.6% for every 1% market move, but says nothing about total risk, which also includes unsystematic risk captured by standard deviation, not beta. A and C wrongly equate beta with total risk/standard deviation; D wrongly treats beta as a guarantee of realized return.
- A. Beta measures only systematic risk, not total risk; it says nothing about company-specific risk.
- B. Correct. Beta of 1.6 means the stock's systematic risk is 60% greater than the market's, tending to move about 1.6% for each 1% market move, but beta is silent on unsystematic, company-specific risk.
- C. Beta and standard deviation are not interchangeable; standard deviation also reflects unsystematic risk, so beta is not a direct measure of total volatility.
- D. Beta describes historical sensitivity to market moves, not a proportional return in every market; it does not predict realized return.
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A portfolio begins a year worth $100,000. At midyear, it is worth $120,000 just before the client adds $100,000; at year-end it is worth $231,000. Assume no other flows. What is the linked time-weighted return for the year?
- A. 15.5%.
- B. 31.0%.
- C. 5.0%.
- D. 26.0%.
Show answer and explanation
Correct answer: D. 26.0%.
Subperiod returns are 120/100 - 1 = 20% and 231/220 - 1 = 5%. Linked: 1.20 x 1.05 - 1 = 26%. Time weighting removes the effect of the client's deposit.
- A. This is not the linked return; the subperiods must be compounded, not averaged or otherwise approximated.
- B. This treats the whole ending balance less total money in as gain relative to the starting balance, mixing in the deposit.
- C. This is only the second-half return; the first-half 20% must also be linked.
- D. Linking 20% and 5% gives 1.20 x 1.05 - 1 = 26%.