CFA Practice Question

There are 221 practice questions for this study session.

CFA Practice Question

Which of the following statements is (are) true with respect to the portfolio management process?

I. Individuals generally define risk in terms of standard deviation.
II. The investment horizon for investors in the accumulation phase will be the longest (relative to the other phases).
III. The level of return that the investor desires will determine how much risk the investment manager should take on.
IV. The investment horizon is deemed to end at the investor's death.
A. I, II, IV only
B. II and III only
C. II only
Explanation: I is incorrect; individuals generally define risk in more subjective terms (for instance, prices below which they would incur a paper loss).

III is incorrect; it's the other way around. The level of risk that the investor can handle will determine what return to expect from the portfolio.

IV is incorrect because the portfolio could still be managed on behalf of beneficiaries even after the client's death. Thus the investment horizon approaches its end when the portfolio is expected to be either fully or partially liquidated.

User Contributed Comments 11

User Comment
Shelton the problem makes me sleepy so let's take a quick shot: drop I, keep II, drop IV (death?), drop III (should?) => D
Adas83 explanation to answer III is incorrect. If A determines B does not mean that B automatically determines A.
volkovv I agree that explanation to III is incorrect. Portfolio manager can either minimize risk for a given level of return or maximize return for a given level of risk. So, hypothetically speaking, if an investor is a risk-taker and requires a ceratin level of return, a portfolio can be constructed to attain that return, and that will determine the risk of that portfolio.
wollogo I think you can argue III either way. Explain to me how that is not minimising risk for a given return? E.g. if the investor desired 15% return this will determine the minimum risk the PM can take (which would be greater than if the investor required 10% return)

Agreed that it is usually expressed the other way round
ehc0791 Agree with wologo/volkovv. If investor requires low return, the manager would take less risk, if investor requires higher return, then more risk. It makes perfect sense.
ThePessimist The point is that the curriculum makes clear that you MUST base return expectations on the investor's ability to accept risk. You CANNOT set risk levels based on desired return.
motoloco You are right pessimist
achu I agree with ThePessimist. Other points are valid in theory but - The CFA institute has made its stance pretty clear.
Debra84 Question to pessimist: where in the curriculu is it made clear that you cannot set risk levels based on desired return? so far, I only see the following statement on page 225 of volume 4:

'a single asset or portfolio of assets is considered to be efficient if no other asset or portfolio of assets offer higher expected return with the same (or lower) risk OR lower risk with the same expected return'
This implies that indeed, if you demand a certain return, you will not find a risk level lower than the one you find in an efficient situation (markowitz assumptions).
Please let me know where your statement is found in the curriculum, otherwise i will keep doubting.. Thanks!
gazza77 Debra: have a look at reading 3 of Subjeect 49: Investment objectives;

Risk tolerance must take precedence before investment objectives.

Something for you to consider. Everyone would like 100% returns, but how many people would like 100% risk?
broadex They always say "Risk before returns"
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