Trading, Monitoring, and Rebalancing

Test ID: 7427799

Question #1 of 158

Question ID: 465565

Which of the following statements regarding econometric models is CORRECT? Econometric models:
ᅞ A) are only useful for forecasting trading costs.
ᅞ B) are not useful for forecasting trading costs or assessing trading effectiveness.
ᅚ C) are used to forecast trading costs and assess trading effectiveness.
Explanation
They can be used to forecast trading costs and assist portfolio managers in determining the size of the trade. They can also
be used to assess trading effectiveness by comparing actual trading costs to forecasted trading costs from the models.

Question #2 of 158

Question ID: 465637

In a flat but oscillating market, which asset allocation strategy outperforms?

ᅞ A) Constant proportion portfolio insurance (CPPI).
ᅚ B) Constant mix.
ᅞ C) Buy and hold.
Explanation
In a flat but oscillating market, constant mix outperforms a comparable buy and hold strategy, which, in turn, outperforms a CPPI
strategy.

Question #3 of 158

Question ID: 465665

Which of the following asset allocation strategies passively assumes that risk tolerance is directly related to wealth levels?

ᅚ A) Buy and hold.
ᅞ B) Constant proportion portfolio insurance (CPPI).
ᅞ C) Constant mix.
Explanation
This is the definition of a buy and hold strategy. Constant mix strategies take a contrarian view of investing in order to maintain a constant
asset allocation regardless of wealth levels. CPPI is a momentum-based strategy that aggressively increases exposure to risky assets in
a rising market.

Question #4 of 158

Question ID: 465592


Which of the following is NOT one of the three components of the CFA Institute's Trade Management Guidelines?
ᅞ A) Processes.
ᅚ B) Measurement tools.
ᅞ C) Disclosures.
Explanation
The CFA Institute's Trade Management Guidelines are split into three parts: processes, disclosures, and record keeping.
These guidelines are meant to assist investment management firms in achieving best execution and maximum portfolio value
for their clients.

Question #5 of 158

Question ID: 465607


Which of the following statements regarding disciplined rebalancing is CORRECT? Disciplined rebalancing (e.g., maintaining
an asset mix at 60% stocks and 40% bonds):
ᅚ A) eliminates periodic departures from the policy mix.
ᅞ B) allows for the possibility of a drifting mix.
ᅞ C) prevents substantial gains from market timing.
Explanation
Disciplined rebalancing prevents drifting of the asset mix with market variability. Evidence suggests that market timing fails to
add value.

Question #6 of 158

Question ID: 465574

A simple logical participation strategy trades:
ᅞ A) early in the day and attempts to minimize market impact.
ᅚ B) with market flow and attempts to minimize market impact.
ᅞ C) with market flow and attempts to minimize opportunity costs.
Explanation
Simple logical participation strategies seek to trade with market flow to minimize market impact.

Question #7 of 158
Which of the following statements regarding the implementation shortfall components is least accurate?
ᅚ A) Missed trade opportunity cost is weighted by the portion of the order that is
filled.
ᅞ B) Missed trade opportunity cost represents the difference between the price at which
the order is cancelled and the original price.

Question ID: 465545



ᅞ C) Realized profit and loss represents the difference between the execution price and the
previous day's closing price.
Explanation
Missed trade opportunity cost is weighted by the portion of the order that is not filled. It is calculated using the difference
between the price at which the order is cancelled and the original price. Realized profit and loss uses the difference between
the execution price and the previous day's closing price. This is divided by the original price and weighted by the portion of the
order filled.

Question #8 of 158

Question ID: 465589

Which of the following is least accurate regarding best execution?
ᅚ A) Best execution can be measured for a single trade.
ᅞ B) Each party to a trade determines what best execution is.
ᅞ C) Best execution cannot be judged separately of the investment decision.
Explanation
Although best execution can be measured ex post over time, it cannot be measured for a single trade. Best execution cannot
be judged independently of the investment decision. Best execution cannot be known with certainty ex ante, it depends on the
particular circumstances of the trade. Each party to a trade determines what best execution is.

Question #9 of 158

Question ID: 465601

The cost of not rebalancing the portfolio includes all of the following EXCEPT:

ᅞ A) holding assets that no longer fit the needs of the client.
ᅚ B) the costs of desirable trades that never happen.
ᅞ C) holding an overpriced asset.

Explanation
This is a cost of trading due to rebalancing.

Question #10 of 158
All of the following are costs associated with rebalancing a portfolio EXCEPT:
ᅞ A) brokerage commissions.
ᅞ B) tax costs.
ᅚ C) deferral costs.
Explanation

Question ID: 465621


Tax costs are the key costs associated with rebalancing a portfolio and are often underestimated. Investors focus on
brokerage commissions and forget trading costs such as market impact, trade execution inefficiencies and opportunity costs.

Question #11 of 158

Question ID: 465631

Which of the following client portfolios is most likely to generate the highest trading costs?
Rebalancing
Portfolio
A

B

Allocation

Discipline Employed


40% Corporate Bonds; 30% Mortgage-Backed

Rebalanced on the last day of

Bonds; 30% Government Bonds

each calendar quarter.

25% Domestic Equity; 25% Real Estate; 25%

Rebalanced within an allowable

International Equity; 25% Corporate Bonds

range of 5% for each asset class.
Rebalanced to precise target

C

40% Domestic Equity; 30% International Equity; 30%
Government Bonds

weights if allocation strays from
target.

ᅞ A) Portfolio A.
ᅚ B) Portfolio C.
ᅞ C) Portfolio B.
Explanation

The key to this question is the rebalancing discipline employed. Portfolio C is rebalanced to the precise target weights if the
allocation strays from those weights, which would result in virtually constant analysis and trading, and thus higher trading
costs. Both of the others have certain thresholds or defined dates for rebalancing, which gives the portfolio more flexibility as
to changes in allocation before any trades would take place.

Question #12 of 158

Question ID: 465518

Which of the following statements best characterizes a limit order? A limit order has:
ᅞ A) price uncertainty and execution uncertainty.
ᅚ B) reduced price uncertainty but retains execution uncertainty.
ᅞ C) price uncertainty but not execution uncertainty.
Explanation
A limit order is an order to trade at the best possible price, subject to the price satisfying the limit price. A limit order
emphasizes the price of execution (the reduction of price uncertainty). It however, may not be filled immediately and may even
go unfilled or partially unfilled. A limit order thus has execution uncertainty.

Question #13 of 158

Question ID: 465538


Which of the following is NOT a characteristic of a liquid market?
ᅞ A) An abundance of traders.
ᅚ B) Homogenous traders.
ᅞ C) Integrity.
Explanation
The factors contributing to liquidity are an abundance and diversity of traders, convenience, and integrity. Homogenous
traders are not diverse.


Question #14 of 158

Question ID: 465624

Which of the following statements regarding rebalancing strategies is least accurate?

ᅞ A) Using futures contracts can significantly enhance the benefits of tactical asset
allocation.

ᅚ B) Market timing strategies will tend to outperform constant mix strategies.
ᅞ C) Drifting mix strategies tend to perform poorly compared to disciplined rebalancing strategies.
Explanation
Market timing strategies have been shown to perform poorly relative to constant mix strategies. The other statements are true.

Questions #15-17 of 158
Carl Allen, CFA, has been assigned the task of documenting some of his company's asset allocation techniques. After the firm
receives accolades in a recent trade magazine article highlighting firms with innovative trading strategies, Allen's supervisor
decides it is time the firm began formally documenting how properly timed allocation shifts can add value to assets under
management. Allen decides he will not only document the firm's specific allocation adjustment strategies, but will also compile
a document listing various allocation techniques. Allen decides to begin with input factors such as investor risk tolerance and
market conditions and work his way to specific techniques designed to take advantage of various opportunities. His overall
plan is to work from theoretical concepts to specific applications.

Question #15 of 158

Question ID: 465662

One of the first concepts Allen has to explain is the idea of holding an "optimal" portfolio. In his mind, Allen decides he has to
adequately explain the two main factors that will allow an investor the ability to hold an optimal portfolio. Which of the following

will dictate the selection of an investor's optimal portfolio?
ᅚ A) The tangential intersection between an investor's indifference curve and the
efficient frontier.
ᅞ B) The global minimum variance portfolio.
ᅞ C) Any intersection between an investor's indifference curve and the investment
opportunity set.
Explanation


An optimal portfolio is any set of assets that maximizes an investor's utility, which is dictated by his indifference curve, with
those assets yielding the highest returns at given risk levels, which are dictated by the efficient frontier. The tangential
intersection of indifference curves with the efficient frontier dictates an investor's optimal portfolio.

Question #16 of 158

Question ID: 465663

Allen has determined there are differential postures an asset manager can take, depending upon whether market conditions
are trending up, trending down, or staying relatively level with significant volatility. Which rebalancing strategy provides the
greatest benefit when markets are trending up or down with little oscillation?
ᅞ A) Constant mix strategy.
ᅞ B) Buy and hold strategy.
ᅚ C) Constant proportion portfolio insurance strategy.
Explanation
When a market is either trending up or down with few oscillations, a constant proportion portfolio insurance (CPPI) strategy will
outperform other strategies. A CPPI strategy will provide increasing exposure to risky assets when asset values are increasing.
An investor will essentially hold an increasing amount of risky assets when their value is increasing. On the other hand, in
markets with a declining trend, investors following a CPPI strategy will be selling risky assets faster than others when markets
are declining.


Question #17 of 158

Question ID: 465664

While conducting his research, Allen determines that some dynamic strategies can use a mathematical formula that can easily
determine the amount of assets one invests in equities. Specifically, one formula Allen discovers is:
$ Invested in stock = m x (assets - floor)

where:

m

= stock investment multiplier

assets

= total assets held in the portfolio (TA)

floor

= the minimum allowable portfolio value (F) (zero risk level)

assets - floor

= cushion or funds that can be put at risk

Realizing that his firm's trading strategies were highlighted in the recent edition of a trade magazine due in part to some timely
exposure increases in trending markets, Allen begins to document how his firm applies this particular mathematical formula.
Since Allen's firm's performance seems exemplary in a trending market, which value of "m" was probably chosen?
ᅚ A) Greater than 1.

ᅞ B) Equal to 1.
ᅞ C) Less than 1.
Explanation
The implication is that Allen's firm made some important choices in a trending market. This indicates a constant proportion
portfolio insurance (CPPI) allocation strategy, which requires that an "m" greater than 1 be chosen. Apparently, Allen's firm
was able to increase exposure to equities quickly enough to take advantage of a trending market and probably was able to
decrease exposures quickly enough before markets may have trended downward.


Question #18 of 158

Question ID: 465629

Rebecca Riley and Daniel Gray are portfolio managers for Silver Wolf Asset Management. The firm believes that rebalancing a
portfolio is important for maintaining an investor's exposure to systematic risk factors and follows a percentage-of-portfolio
approach to rebalancing. Riley and Gray each recently brought a new client to the firm and are starting to establish guidelines
for investing their portfolios. Riley states, "My client has a low tolerance for risk, so I am setting wide tolerance corridors for
rebalancing. If the market takes a downturn, the client will not want his fixed income assets sold to purchase more equities."
Discussing his client, Gray says, "My client's portfolio consists largely of small-cap domestic equities, emerging market
equities, and high yield bonds. Since the asset classes in his portfolio are relatively volatile, I am also setting wide tolerance
corridors, or else I would be rebalancing his portfolio practically all the time."

With regard to their statements about the effects of factors on the width of the tolerance corridors:
ᅞ A) Riley's statement is correct; Gray's statement is correct.
ᅚ B) Riley's statement is incorrect; Gray's statement is incorrect.
ᅞ C) Riley's statement is incorrect; Gray's statement is correct.
Explanation
Both Riley's statement and Gray's statement are incorrect. Based on the criteria they have stated - they should be setting tight
tolerance corridors for rebalancing purposes. Riley said that her client has a low risk tolerance. With a low risk tolerance,
tolerance corridors should be smaller in order to detect corridor violations and take action to avoid an even worse violation. If

the portfolio is allowed to drift, riskier assets in the portfolio will tend to take over. With volatile asset classes, Gray's client
should also have small tolerance corridors. When an asset class is volatile and/or the rest of the assets are volatile, the
tolerance corridor should be small to give the portfolio manager the ability to detect any violation in the allocation and react
quickly to avoid an even worse violation.

Question #19 of 158

Question ID: 465639

Which of the following statements about asset allocation strategies is CORRECT? Constant mix:
ᅞ A) outperforms buy and hold when stock market reversals do not occur.
ᅚ B) outperforms buy and hold when stock market reversals occur.
ᅞ C) is a convex strategy.
Explanation
Constant mix is a concave strategy.

Question #20 of 158
Which of the following trading costs results when an order is not filled?
ᅞ A) Price impact costs.
ᅚ B) Delay costs.

Question ID: 465540


ᅞ C) Market impact costs.
Explanation
When an order is not filled, delay or slippage costs result. These costs can be substantial if information regarding the security
is released while the order sits unfilled.

Question #21 of 158


Question ID: 465658

Which of the following statements about convex and concave strategies is least accurate?

ᅞ A) The constant mix payoff curve is concave.
ᅚ B) For constant proportion portfolio insurance (CPPI) strategies, the payoff curve is concave.
ᅞ C) No downside protection exists for constant mix strategies.
Explanation
For CPPI strategies, the payoff curve is convex. The other statements are true.

Question #22 of 158

Question ID: 465656

Which of the following statements about asset allocation strategies is least accurate?

ᅞ A) The constant proportion portfolio insurance (CPPI) strategy is a convex strategy.
ᅞ B) The constant proportion portfolio insurance (CPPI) strategy has a payoff diagram similar to
that of a protective put.

ᅚ C) Strategies for which the slope of the exposure diagram is greater than one give rise to
concave payoff diagrams.

Explanation
An exposure diagram for an asset allocation strategy plots the desired stock position (y-axis) against the value of the portfolio (x-axis).
Strategies with concave payoff diagrams (y-axis = portfolio value, x-axis = stock market value), such as the constant mix strategy, have
exposure diagrams with slopes between zero and one.

Question #23 of 158

Which of the following statements about constant proportion rebalancing strategies is least accurate?

ᅚ A) It is a concave strategy.
ᅞ B) The strategy does well in a bull market.
ᅞ C) The strategy is protected on the downside.
Explanation
Constant proportion is a convex strategy.

Question ID: 465643


Question #24 of 158

Question ID: 465560

Which of the following measures is least susceptible to gaming by traders?
ᅞ A) Effective spread.
ᅚ B) Implementation Shortfall.
ᅞ C) VWAP.
Explanation
The measurement least susceptible to gaming would be the implementation shortfall measure. VWAP can be gamed by
traders, who might time their trades until the VWAP makes their trading costs appear favorable. The effective spread can also
be gamed. A trader can trade at favorable bid and asks by waiting for orders to be brought to them.

Question #25 of 158

Question ID: 465595

Which of the following statements regarding a buy-side trader's priority is CORRECT?
ᅞ A) Their relationship with sell-side trader must come first.

ᅞ B) Their relationships with their broker, the client, and sell-side traders are of equal
priority.
ᅚ C) Their relationship with the client must come first.
Explanation
The buy-side trader should always be acting in the best interests of their clients. Buy-side traders and portfolio managers have
a fiduciary duty to maximize the value of their client's portfolio. The buy-side trader's relationships with sell-side traders must
never come before the interests of their clients.

Question #26 of 158

Question ID: 465593

Which of the following is least accurate regarding best execution, the CFA Institute's Trade Management Guidelines, and
ethics in trading?
ᅞ A) The buy-side trader's relationship with clients must come before their
relationship with sell-side traders.
ᅞ B) Record keeping is a key component of the CFA Institute's Trade Management
Guidelines.
ᅚ C) Best execution should be measured over short, relevant time periods.
Explanation
Although best execution can be measured ex post over time, it should not be used to evaluate trading effectiveness over a
short time span. Buy-side traders and portfolio managers have a fiduciary duty to maximize the value of their client's portfolio.


Question #27 of 158

Question ID: 465608

Jim Cantore is a 45 year old client with a $1.5 million portfolio that is heavily weighted toward equities. Cantore will continue working for
the next 20 years and has a substantial retirement portfolio through his current employer.

Cantore's three children are now nearing college age and will all attend premiere universities in the U.S. which each cost $50,000 per year
to attend. All college expense will be paid out of Cantore's portfolio. Cantore should:

ᅚ A) Rebalance his portfolio toward high quality, intermediate-term debt instruments to
service the expected liquidity needs of his portfolio.

ᅞ B) Rebalance his portfolio toward large-cap common stocks and international securities because
education costs are highly correlated with the returns to these securities.

ᅞ C) Not rebalance his portfolio because his children should all pay their own way through school.
Explanation
The liquidity needs of sending his children to school should take precedence over his retirement needs, which are already well funded.

Question #28 of 158

Question ID: 465588

Which of the following is least accurate regarding best execution?
ᅞ A) Best execution can be measured after the fact for a series of trades.
ᅞ B) Best execution can determine a trader's effectiveness over time.
ᅚ C) Best execution prevents high cost trades from taking place.
Explanation
Some strategies might have high trading costs but that does not mean they should not be pursued if in net they enhance
portfolio value. Best execution can be measured after the fact for a series of trades.

Question #29 of 158

Question ID: 465533

Which of the following relationships is adversarial?

ᅞ A) Trader and broker.
ᅚ B) Trader and dealer.
ᅞ C) Broker and dealer.
Explanation
The relationship between a trader and a dealer is adversarial. The dealer would like to maximize the trade spread and the
trader would like to minimize it. Also, when a trader has information that the dealer does not, the trader profits at the dealer's
expense.

Question #30 of 158

Question ID: 465570


Which of the following trade motivations would most likely use a low-cost-whatever-the-liquidity trading focus?
ᅞ A) Liquidity and value-motivated.
ᅞ B) Liquidity and information-motivated.
ᅚ C) Passive and value-motivated.
Explanation
In a low-cost-whatever-the-liquidity trading focus, the trader places a limit order outside of the current bid-ask quotes in order
to minimize trading costs. The strength of this strategy is that commissions, spreads, and market impact costs tend to be low.
Passive and value-motivated traders will often purse this patient strategy. Information and liquidity motivated trades need more
immediate execution and thus would not use this strategy.

Question #31 of 158

Question ID: 465640

Consider two identical $10,000 portfolios, each with a 75% allocation to stock and a 25% cash allocation. One portfolio is being managed
to a buy and hold strategy with an initial stock/total value ratio of 0.75. The other is being managed to a constant mix strategy with a
desired stock/total value ratio of 0.75. Beta for the stock component of both portfolios is equal to one. Now, assume that the stock market

instantly decreased from an index value of 1,000 to 900 and, a short while later, jumped back to the 1,000 level. The difference between
the final value of the two portfolios is closest to which of the following?

ᅞ A) The constant mix portfolio will be worth $187.50 more than the buy-and-hold portfolio.
ᅚ B) The constant mix portfolio will be worth $20.83 more than the buy-and-hold portfolio.
ᅞ C) There is no difference between the final value of the buy-and-hold portfolio and the constant
mix portfolio.

Explanation
Buy and hold portfolio: After the 10% decrease in the market, the value of the stock in the buy-and-hold portfolio is 0.9 x $7,500 = $6,750.
Combined with the cash value of $2,500, the total value of the portfolio is $2,500 + $6,750 = $9,250. When the market returns to 1,000, an
increase of 11.11% (100/900), the stock value is 1.111($6,750) = $7,500, and the total portfolio value returns to $10,000 = $2,500 +
$7,500.
Constant mix portfolio: After the 10% decrease in the market, the portfolio consists of $2,500 in cash and 0.9 x $7,500 = $6,750 in stock,
for a total value of $9,250. This represents a stock/total asset ratio of 6,750/9,250 = 0.7297. To maintain the desired 0.75 stock/total
asset mix, additional stock must be purchased. The amount of stock that must be repurchased is determined as follows:
($6,750 + X)/$9,250 = 0.75, or X = $187.50.

After the purchase of $187.50 in additional stock, the portfolio consists of stock valued at $6,937.50 = $6,750 + $187.50 and cash in the
amount of $2,500 - $187.50 = $2,312.50. Following the 11.11% increase in the stock market, the constant mix portfolio value is equal to:
$2,312.50 + 1.1111($6,937.50) = $10,020.83.

Thus, the ending value of the constant mix portfolio is $20.83 greater than that of the buy-and-hold portfolio. This demonstrates that a
constant mix strategy outperforms a buy-and-hold strategy in a flat, oscillating market.


Question #32 of 158

Question ID: 465670


Which of the following strategies is most appropriate for an investor whose risk tolerance drops to zero when the value of the portfolio
drops below a floor value?

ᅚ A) Both of these responses are correct.
ᅞ B) Buy and hold.
ᅞ C) Constant proportion portfolio insurance.
Explanation
In each of these strategies, risk tolerance is zero when the value of assets drops below the floor. Under buy and hold, the floor value is
the original amount invested in T-bills.

Question #33 of 158

Question ID: 465537

Which of the following is NOT a relevant measure of market quality?
ᅞ A) Liquidity.
ᅞ B) Assurity of completion.
ᅚ C) Market prevalence.
Explanation
A security market should be judged on the basis of its liquidity and assurity of completion.

Question #34 of 158

Question ID: 465609

Mimi Smith, a client of Osborne Capital, Inc., believes that her portfolio should be rebalanced. She supports her claim by stating that she
just won the lottery and wants to retire 10 years earlier than before. Does she have a valid claim?

ᅚ A) Yes. Her wealth and time horizon have changed.
ᅞ B) Yes. Her time horizon has changed.

ᅞ C) No. Not enough information is given to determine.
Explanation
Changes in wealth, time horizon, and liquidity requirements all dictate the need to rebalance. Taxes, laws, and regulations, as well as
unique circumstances, also play into this decision.font>

Question #35 of 158

Question ID: 465583

Use the following information to determine how the trades should be placed for the following shares.

Stock Ticker Trade Size Average Daily Volume Spread Urgency
ABCD

20,000

400,000

0.04%

Low


LMNO

60,000

1,000,000

0.07%


High

WXYZ

75,000

150,000

0.60%

Low

ᅞ A) ABCD should be traded using a shortfall implementation strategy, LMNO should be
traded using a simple logical participation strategy, and WXYZ should be placed with a
broker.
ᅚ B) ABCD should be traded using a simple logical participation strategy, LMNO should be traded
using a shortfall implementation strategy, and WXYZ should be placed with a broker.
ᅞ C) ABCD should be traded using a shortfall implementation strategy, LMNO should be placed
with a broker, and WXYZ should be traded using a simple logical participation strategy.

Explanation
The trade for stock WXYZ is large relative to average daily trading volume (75,000/150,000 = 50%) and has a large spread. Because of
these characteristics, it should be traded through a skilled broker or through a crossing system to minimize the spread. The trade for
stock ABCD is relatively small (20,000/400,000 = 5%) and the spread is low. The ABCD trade is of low urgency and can be traded over
time. It is thus suitable for a simple participation strategy based on VWAP or other benchmark. The LMNO trade is of small relative size
(60,000/1,000,000 = 6%), has small spreads, and high urgency. It should be traded more quickly using an implementation shortfall
strategy.

Question #36 of 158


Question ID: 465642

Which of the following statements about constant mix rebalancing is least accurate?
ᅞ A) As stock prices rise, the stock to total assets ratio increases, so stocks should be sold.
ᅞ B) As stock prices fall, the stock to total assets ratio decreases, so stocks must be purchased.
ᅚ C) As stock prices rise, the stock to total assets ratio increases, so stocks should be
purchased.

Explanation
To maintain the constant mix, when stock prices rise, stocks must be sold.

Question #37 of 158

Question ID: 465628

The model portfolio for Yazbeck Capital Management consists of the following allocation:
Asset Class

Allocation

Intermediate U.S. Government bonds

45%

Intermediate U.S. Corporate bonds

45%

Large Cap U.S. equities


10%

One of the primary tenets of Yazbeck's Investment Process is to rebalance portfolios based on a percentage-of-portfolio approach with
tolerance corridors for each asset class. Two of Yazbeck's portfolio managers, Justin Croniser and Kevin Hopkins are discussing the size
of the corridor width for each asset class. Croniser states, "The high correlation between U.S. Government bonds and U.S. Corporate


bonds implies that both asset classes should stay within acceptable limits even if we decide to set relatively small corridors." Hopkins
replies, "Even if that were true, the high liquidity of U.S. Government bonds implies that the corridor for that asset class should be
relatively wide."

The founder of Yazbeck Capital Management, Shadya Yazbeck is listening to their conversation. Yazbeck should:

ᅚ A) agree with Croniser's statement, but disagree with Hopkins' statement.
ᅞ B) disagree with Croniser's statement and disagree with Hopkins' statement.
ᅞ C) agree with Croniser's statement and agree with Hopkins' statement.

Explanation
Yazbeck should agree with Croniser's statement. A high degree of correlation between asset classes means that the assets will tend to
move together. For example, if interest rates rise, the prices of U.S. Government and corporate bonds are likely to fall by similar amounts
and thus are likely to stay within acceptable ranges. High correlations between asset classes mean that they are likely to stay in range
together even if corridors are small. Conversely, assets that have zero or negative correlation will tend to move opposite one another, and
thus are more likely to exceed corridor limits. Yazbeck should disagree with Hopkins' statement. The more liquid an asset class is, the
lower the transaction costs for trading that asset. Since transaction costs are minimal for government bonds, a small corridor would not do
much to increase aggregate trading costs. In contrast, an illiquid asset class (i.e. private equity) would have high trading costs and should
have a wider corridor to compensate.

Question #38 of 158


Question ID: 465625

Tyrone Wilkins and Deborah Ortiz are portfolio managers for Meabon Asset Management. Both Wilkins and Ortiz believe that rebalancing
is an important part of portfolio management, but are unsure which rebalancing method would be best for their respective clients. Wilkins
wants to maintain his client's exposure to systematic risk factors, but does not want to spend his time constantly monitoring his client's
portfolio. Ortiz is most concerned that two or more asset classes in the portfolio could stray too far from the portfolio's target allocation.
Given their concerns, which rebalancing method would be best for Wilkins and Ortiz respectively?

Rebalancing Method for Wilkins

Rebalancing Method for Ortiz

ᅞ A) Percentage-of-Portfolio

Monte Carlo Portfolio

ᅞ B) Percentage-of-Portfolio

Calendar

ᅚ C) Calendar

Percentage-of-Portfolio

Explanation
The two primary methods of rebalancing are calendar rebalancing and percentage-of-portfolio rebalancing - Monte Carlo is not a
rebalancing method. With calendar rebalancing, the portfolio is rebalancing on a predetermined date. Since calendar rebalancing provides
discipline without the need for constant monitoring, calendar rebalancing would be appropriate for Wilkins. Percentage-of-portfolio
rebalancing is triggered by changes in value rather than calendar dates. Since Ortiz is most concerned about asset classes straying from
a target allocation, Ortiz could use percentage of portfolio rebalancing to set a target corridor for each asset class and rebalance the

portfolio when the portfolio's asset allocation moves outside of the corridor.


Question #39 of 158

Question ID: 465530

Where would an illiquid security in a developing country most likely trade?
ᅞ A) Electronic crossing networks.
ᅚ B) Broker markets.
ᅞ C) Electronic limit-order markets.

Explanation
In brokered markets, brokers find the counterparties to a trade. This service is valuable when the trader has a large block to sell, when
they want to remain anonymous, and/or when the market for the security is small or illiquid. Brokered markets are important in countries
where public capital markets are not well developed.

Questions #40-43 of 158
Kim and Darren Jones are both 55 years old and want to retire within the next 12 - 18 months. They currently have the following portfolio:

Asset Class

%

Small cap growth

35

Large cap value


30

High yield bonds

30

T-bills

0

Corporate bonds

5
100

Question #40 of 158

Question ID: 465603

What can be said about the current allocations?
ᅞ A) Properly diversified.
ᅞ B) Not aggressive enough.
ᅚ C) Too aggressive.

Explanation
Considering the Jones are very close to retirement, the current equity portion of the portfolio should be reduced. At 65%, it could be
debated that equities are properly represented, but, considering the equity tendencies of high yield bonds, this pushes the allocation to
95%. With no cash, liquidity will need to be increased to fund their living expenses.

Question #41 of 158

Which sector should be increased?
ᅞ A) Small cap growth stocks.
ᅚ B) Corporate bonds.
ᅞ C) Large cap value stocks.

Question ID: 465604


Explanation
Considering the Jones are very close to retirement, the current equity portion of the portfolio should be reduced. At 65%, it could be
debated that equities are properly represented. But, considering the equity tendencies of high yield bonds, this pushes the allocation to
95%. With no cash, liquidity will need to be increased to fund their living expenses.

Question #42 of 158

Question ID: 465605

Two years have passed and the Jones are in retirement. They now realize the asset allocation problems with their portfolio. They enlist
the aid of Snipes & Son, an investment advisory firm. Snipes proposes the following four portfolios:

Asset Class
Small cap

A

B

C

D


5%

0% 15% 5%

5%

0% 25% 10%

High yield bonds 5%

0% 20% 10%

growth
Large cap value

T-bills

35% 0% 10% 5%

Corporate bonds 50% 100% 30% 70%
Based solely on the information provided, which portfolio would serve the Jones best?

ᅚ A) Portfolio D.
ᅞ B) Portfolio C.
ᅞ C) Portfolio A.

Explanation
At 70%, it can be argued that the corporate bond allocation is too high. However, based on the other alternatives, it is the best available.
Income from the bonds can be used for living expenses while the 5% cash allocation can provide for emergency expenses. The equity

component can facilitate the need to outpace inflation.
Portfolio A is underweighted in equities, portfolio B has too much invested in bonds, portfolio C is overweighted in equities at 60% if high
yield bonds are viewed more as an equity than a bond. Portfolio C is also underweighted in bonds at only 30% in corporate bonds with Tbills equaling the cash component.

Question #43 of 158
Which of the portfolios would yield the lowest expected return?
ᅞ A) Portfolio D.
ᅞ B) Portfolio B.
ᅚ C) Portfolio A.

Explanation
With 35% cash, the expected return will be substantially lower than the other investment choices.

Question ID: 465606


Question #44 of 158

Question ID: 465572

Which of the following trading tactics would most likely be used by an information-motivated trader?
ᅞ A) Costs-are-not-important.
ᅞ B) Need-trustworthy-agent.
ᅚ C) Liquidity-at-any-cost.

Explanation
In a liquidity-at-any-cost trading focus, the trader must transact a large block of shares quickly, typically because they possess timesensitive information. The liquidity-focused trader must be ready to pay a high price for trading in the form of market impact and/or
commissions.

Question #45 of 158


Question ID: 465519

A market order has:
ᅚ A) price uncertainty but not execution uncertainty.
ᅞ B) execution uncertainty but not price uncertainty.
ᅞ C) both price uncertainty and execution uncertainty.

Explanation
A market order is an order to execute the trade immediately at the best possible price. The emphasis in a market order is the speed of
execution (the reduction of execution uncertainty). The disadvantage of a market order is that the price it will be executed at is not known
ahead of time, it thus has price uncertainty.

Question #46 of 158

Question ID: 465591

Which of the following is least accurate regarding the CFA Institute's Trade Management Guidelines? They state that investment
management firms:
ᅞ A) must disclose their conflicts of interest related to trading.
ᅞ B) should strive for best execution.
ᅚ C) must not disclose documentation concerning policies and procedures to outside parties.

Explanation
Documentation concerning policies and procedures to outside parties should be disclosed to outside regulators, not held within the firm.
The CFA Institute's Trade Management Guidelines state that in regard to record keeping, investment management firms should maintain
the documentation supporting: 1) the firm's compliance with its policies and procedures; and 2) disclosures made to its clients. In doing
so, the firm provides evidence to regulators as to how the firm pursues best execution for its clients.

Question #47 of 158


Question ID: 465567


Information-motivated traders emphasize:
ᅚ A) time in their trading and use market orders.
ᅞ B) price in their trading and use market orders.
ᅞ C) price in their trading and use limit orders.

Explanation
Information-motivated traders have information that is time sensitive, and if they do not trade quickly, the value of their information will
expire. They, therefore, emphasize time in their trades. They use market orders to execute quickly and because these orders are less
noticeable.

Questions #48-51 of 158
Allen and Hanes joined Tacticon five years ago, fresh out of college. They are now both convinced that properly timed allocation shifts
can add value to the investment process. The equity market trended upward for the first three years of their tenure, but has been slowly
declining ever since. In spite of the lackluster performance of the markets in general, the firm has produced exceptional annual and 5-year
trailing returns. Both analysts are certain that Tacticon's ability to generate positive alpha is the result of a superior investment system.
Ridley wants Allen and Hanes to record the specifics of Tacticon's investment process for internal use. He also wants them to compile a
document explaining a variety of allocation techniques to be used by the marketing staff and portfolio managers when working with
prospects and clients.
While conducting his research, Allen notes that certain dynamic strategies can use a mathematical formula to determine the amount of
equities that should be held. Specifically, one formula Allen finds is:

Allen decides to organize his thoughts about asset allocation by constructing a matrix that compares some of the different strategies. His
first draft is detailed in Exhibit A below.

Exhibit A - Dynamic Asset Allocation Strategies
Strategy


Shape of Payoff Diagram

Performs Well In

Buy and Hold

Straight line

Upward trending markets

Constant Mix

Concave

Constant Proportion Portfolio Insurance (CPPI)

Question #48 of 158

Question ID: 465680

Hanes is having difficulty completing Exhibit A as he is unsure of the shape of the payoff diagram for CPPI. The correct shape for the
CPPI payoff diagram is:
ᅚ A) convex.


ᅞ B) straight-line.
ᅞ C) concave.

Explanation

CPPI has a convex payoff diagram. A strategy that generates a convex payoff function is equivalent to buying portfolio insurance (like a
protective put). Such strategies are suited for investors whose risk tolerance increases as asset values climb and decreases as asset
values fall.

Question #49 of 158

Question ID: 465681

Which strategy in Exhibit A provides the greatest benefit when markets are trending up or down with little oscillation?
ᅚ A) Constant proportion portfolio insurance.
ᅞ B) Buy and hold strategy.
ᅞ C) Constant mix strategy.

Explanation
When a market is either trending up or down (with low volatility), a CPPI strategy will outperform other strategies. A CPPI strategy will
provide increasing exposure to risky assets when asset values are increasing. An investor will essentially hold an increasing amount of
risky assets when their value is increasing. On the other hand, investors following a CPPI strategy will be selling risky assets faster than
others as markets decline.

Question #50 of 158

Question ID: 465682

Allen realizes that his firm's trading success might have been due to use of the mathematical formula he found. Since Tacticon's
performance was exemplary over the past five years, which value of "m" was probably chosen?
ᅚ A) Greater than 1.
ᅞ B) Equal to 1.
ᅞ C) Less than 1.

Explanation

The implication is that Allen's firm made some important choices in the trending market. This indicates a CPPI allocation strategy, and
implies that an "m" greater than 1 was chosen. Apparently, Allen's firm was able to increase exposure to equities quickly enough to take
advantage of the upward trending market, and was able to decrease exposures quickly enough to protect its clients as markets trended
downward.

Question #51 of 158

Question ID: 465683

Constant mix rebalancing involves:
ᅞ A) holding either all cash or all equities.
ᅚ B) buying the asset whose price falls; selling the asset whose price rises.
ᅞ C) buying the asset whose price rises; selling the asset whose price falls.

Explanation
Rebalancing under a constant mix strategy requires buying the asset whose price falls and selling the asset whose price rises. This


produces a concave payoff diagram.

Question #52 of 158

Question ID: 465522

Suppose a trader is quoted a market bid price of $40.40 and an ask of $40.49. The execution price of a buy order is $40.47. What is the
effective spread?
ᅚ A) $0.050.
ᅞ B) $0.025.
ᅞ C) $0.090.


Explanation
If a trader placed a buy order, a dealer may offer a better ask price than the previous ask to earn the trader's business. The midquote of
the quoted bid and ask prices is $40.445. The effective spread for this buy order would then be calculated as: 2 × ($40.47 - $40.445) =
$0.05, which is 4 cents better than the quoted spread of $0.09 ($40.40 - $40.49).

Question #53 of 158

Question ID: 465569

Jack Steele has just determined using analysis that the prospects for Titan Steel are favorable. He would like to trade before other
investors realize Titan's prospects. What type of trade should he use?
ᅞ A) limit.
ᅞ B) participate.
ᅚ C) market.

Explanation
Steele is an information-motivated trader. These traders have information that is time sensitive, and if they do not trade quickly, the value
of their information will expire. They use market orders to execute quickly and because these orders are less noticeable.

Question #54 of 158

Question ID: 465630

Stuart Steinberg, a portfolio manager for Weber Capital Advisors, uses a percentage-of-portfolio rebalancing approach when rebalancing
his client portfolios, but is unsure how to set the optimal corridor width for each asset class. Steinberg is evaluating the following factors
for a particular asset class.
Factor 1: The asset class has a tendency to be extremely volatile.
Factor 2: The asset class has a low trading volume and a high bid-ask spread.
Factor 3: When comparing the asset class to the rest of the portfolio, the volatility for the rest of the portfolio is high.


Which of the factors would lead Steinberg to set a large corridor for the asset class?

ᅚ A) Factor 2 only.
ᅞ B) Factors 1 and 2 only.


ᅞ C) Factors 2 and 3 only.

Explanation
When an asset class is volatile and/or the rest of the assets are volatile, the tolerance corridor should be small to give the portfolio
manager the ability to detect any violation in the allocation in the asset class and react quickly enough to avoid an even worse violation.
However, in this example the low trading volume and high bid-ask spread implies a large corridor. When an asset class is illiquid and
transactions costs are high, the corridor should be wider to try to avoid frequent trading.

Question #55 of 158

Question ID: 465620

Which of the following statements about trading strategies is CORRECT?
ᅞ A) A buy and hold strategy is best with respect to asset allocation because it has the
lowest trading costs.
ᅞ B) A disciplined rebalancing strategy typically underperforms a buy and hold strategy.
ᅚ C) A buy and hold strategy may not satisfy the current asset allocation needs of a client.

Explanation
Buy and hold strategies "drift" over time. Because of this, initial asset allocation decisions may not be evident in the resulting portfolio.
Disciplined rebalancing performs better than buy and hold strategies in a flat but oscillating market.

Question #56 of 158


Question ID: 465535

In which of the following relationships does the adverse selection risk problem pertain?
ᅞ A) Trader and investor.
ᅚ B) Trader and dealer.
ᅞ C) Trader and broker.

Explanation
A trader is more likely to trade with a dealer when he has information that the dealer does not. This results in adverse selection risk for the
dealer. The trader's profit is the dealer's loss once the information is revealed to the market.

Question #57 of 158

Question ID: 465599

Heidi Burke was recently hired by Beekley Capital Advisors as a portfolio manager. On her first day on the job, Cynthia Beekley, owner
and founder of the firm, asks Burke to write down the fiduciary responsibilities of a portfolio manager as they pertain to monitoring a
client's portfolio. Burke writes down the following items and hands the paper to Beekley.

Item 1:

Watch for changes in client objectives that may necessitate changes to the portfolio.

Item 2:

Construct the investor's portfolio to meet the needs of the client as specified in the IPS.

Item 3:

Identify changes in capital market conditions and asset class risks.


Item 4:

Look for changes in client constraints that could cause changes in the client's allocation.


Item 5:

Avoid trying to make tactical timing changes to a client portfolio because evidence shows that market timing
increases risk without increasing return.

Which of the following most accurately describes Burke's statements?

ᅞ A) Only Item 3 addresses Beekley's question, while Items 1 and 4 would be part of a
client's investment policy statement.
ᅚ B) Only Items 1, 3, and 4 address Beekley's question, while Item 2 is a fiduciary duty not related
to monitoring.
ᅞ C) Only Items 1 and 4 address Beekley's question, while Items 2 and 5 are a fiduciary duties not
related to monitoring.

Explanation
Since the portfolio manager is in a position of trust, he has the fiduciary duty to construct the needs of the client as specified in the IPS
and the duty to monitor the portfolio to be sure it continues to meet the client needs. The monitoring process includes monitoring a client's
objectives and constraints as well as changes in market conditions. Therefore, Item 2 is a fiduciary duty not related to monitoring, while
Items 1, 3, and 4 address fiduciary duties related to monitoring. Item 5 is not necessarily true since a skilled manager could use tactical
asset allocation to reduce risk and/or increase returns.

Questions #58-63 of 158
Michelle Nack has a problem. She just took over for a portfolio manager who bolted unceremoniously from money manager Masters and
Ickes, leaving his accounts in disarray. Nack has been tasked with sorting out the mess.

She has connected most of the investment policy statements with the appropriate accounts, but three accounts, each valued at
$100,000, are not named. The accounts contain the following assets:

Portfolio A Portfolio B Portfolio C
Large-Cap Stocks

$55,000

Small-Cap Stocks

$10,000

Private Equity

$45,000

$70,000
$10,000

$15,000

Commodities

$10,000

Real Estate

$5,000

$20,000


$25,000

Short-Term Corporate Bonds $10,000

$5,000

$5,000

Cash

$5,000

$5,000

Long-Term Corporate Bonds

$5,000

Nack is trying to match the accounts with clients for whom no other accounts have been found.
Johnson is a 55-year-old executive who was recently promoted to a senior-management position at a pharmaceutical company.
Kent is a 26-year-old assistant manager of a restaurant.
Lerner is a 70-year-old owner of a copper mine who retired from the business 20 years ago.
After Nack has been on the job for six months, she is still not sure who owns Portfolio A. However, substantial moves of the market


suggest that it is time to rebalance the portfolio. The portfolio notes infer that a CPPI strategy should be used, with a coefficient of 2 and
a $70,000 floor. Here are the portfolio weights after six months:

Portfolio A

Large-Cap Stocks

$47,600

Small-Cap Stocks

$9,750

Long-Term Corporate Bonds

$20,500

Short-Term Corporate Bonds $10,150
Cash

$5,000

Another six months has passed since Nack rebalanced Portfolio A. The market has been quite volatile, and Nack wants to rebalance
again. Because she still does not know to whom the portfolio belongs, she decides to reconsider the rebalancing strategy in an effort to
maximize portfolio return. The current allocation is as follows:

Portfolio A
Large-Cap Stocks

$58,950

Small-Cap Stocks

$12,500


Long-Term Corporate Bonds

$18,400

Short-Term Corporate Bonds $10,050
Cash

$5,000

Nack decides to rebalance using a constant-mix strategy this time, reasoning that the original asset mix was what the first portfolio
manager considered best for the unnamed client. Going forward, Nack isn't sure about the market's direction. The research department at
Masters and Ickes has produced divergent forecasts, with some analysts projecting a flat market with lots of volatility and some
projecting a sustained upward trend.
When Nack submits her trades to the Masters and Ickes trading desk, they are handled by Wilbur Wallace, a 30-year veteran trader.
Wallace handles most of the company's rebalancing trades, and he is almost always more concerned about the price of trades than the
timing. For that reason, he generally uses limit orders.

Question #58 of 158

Question ID: 485136

Which investors appear to be the best fit for:
Portfolio B?

Portfolio C?

ᅞ A) Lerner

Johnson


ᅚ B) Johnson

Kent

ᅞ C) Johnson

Lerner

Explanation
Portfolio C has the most invested in equity and alternative investments such as the hedge fund and the least invested in bonds thus it is
most suited to someone who can tolerate more risk such as Kent who is only 26 years old. Since Lerner is the oldest at 70 years old and


still owns the copper mine he would not benefit from the private equity or real estate investments in portfolio B. Also, private equity could
have a long lock up period which would not be appropriate for an older person. Since portfolio B has a higher concentration of long term
bonds than portfolio A, portfolio B is more interest rate sensitive making it less appropriate than portfolio A for Lerner. Johnson on the
other hand is younger than Lerner and can therefore tolerate the longer lock up period of the private equity in portfolio B and greater
interest rate sensitivity of the higher concentration of long term bonds in portfolio B. (Study Session 16, LOS 31.j)

Question #59 of 158

Question ID: 485137

After Nack rebalances Portfolio A the first time, its bond holdings should:
ᅞ A) decline by $1,550.
ᅞ B) rise by $1,600.
ᅚ C) rise by $11,350.

Explanation
To calculate the targeted stock holding, multiply the stock multiplier by (total assets - portfolio floor).

Total assets = $93,000.
Portfolio floor = $70,000.
Stock multiplier = 2.
The new stock holdings = 2 × ($93,000 − $70,000) = $46,000.
Current stock holdings are $57,350, so we must sell $11,350 in stocks to hit the target, which means that the bond holdings will rise by
$11,350. (Study Session 16, LOS 31.h)

Question #60 of 158

Question ID: 485138

Wallace is a:
ᅞ A) liquidity-motivated trader.
ᅞ B) value-motivated trader.
ᅚ C) passive trader.

Explanation
Traders who make moves for the purchase of reallocating assets or dealing with liquidity issues are called passive or liquidity-oriented
traders. Liquidity-oriented traders are more concerned with time than price, because they are willing to pay for liquidity when they need it.
Wallace is price-sensitive rather than time-sensitive, which classifies him as a passive trader. (Study Session 16, LOS 30.j)

Question #61 of 158

Question ID: 485139

The owner of Portfolio B appears least concerned about:
ᅞ A) income.
ᅚ B) liquidity.
ᅞ C) volatility.


Explanation
The portfolio does contain a fair amount of income-producing bonds, and the diversification of the portfolio could suggest some interest in
limiting volatility and the effect of market downturns. But the presence of real estate and private equity in the portfolio suggest the owner


is not concerned about liquidity. (Study Session 16, LOS 31.c, f)

Question #62 of 158

Question ID: 485140

After rebalancing Portfolio A the second time, if Nack's goal is to maximize return potential while limiting potential loss of principal, her
best rebalancing strategy is:
ᅞ A) constant mix.
ᅞ B) constant proportion.
ᅚ C) buy and hold.

Explanation
A constant-mix strategy outperforms in a flat but oscillating market but underperforms in a trending market. A constant-proportion strategy
outperforms in a trending market but underperforms in a flat but oscillating market. Buy and hold limits downside by keeping funds in cash
or bonds, while it performs well in an upward-trending market and is roughly flat in an oscillating market. If Nack doesn't have any insight
on where the market is going and wants to limit loss of principal, buy and hold is the best option of those offered, especially considering
that her analysts are projecting either a flat or upward market, but not a downward market. (Study Session 16, LOS 31.h)

Question #63 of 158

Question ID: 485141

When Nack rebalances Portfolio A the second time, the portfolio's stock allocation is most likely to fall by:
ᅚ A) 3.11%.

ᅞ B) 6.45%.
ᅞ C) 3.33%.

Explanation
At the time of the second rebalancing, the portfolio's stock weighting is 68.11%. Constant-mix rebalancing assumes the purchase or sale
of stock sufficient to return the portfolio to its original weighting, in this case 65%.
68.11% − 65% = 3.11%
(Study Session 16, LOS 31.h, j)

Question #64 of 158

Question ID: 465655

A constant mix strategy:
ᅞ A) exhibits good upside potential.
ᅞ B) performs poorly in flat, oscillating markets.
ᅚ C) performs much like a covered call position.

Explanation
Constant mix performs best in flat, oscillating markets, much like a covered call strategy. Constant mix has weak upside potential in that
the strategy reduces exposure to risky assets in an increasing market.