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CFA Level I Portfolio Management Practice Questions

Official outline
CFA Institute 2026 Level I Topic Outlines (learning outcomes)
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8
Updated
Nov 3, 2026
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8-12%

  1. Question 1, hard

    A stock has an expected (required) return of 21%. The risk-free rate is 5%, and the expected return on the market portfolio is 13%. Based on the CAPM, what is the stock's beta?

    • A.1.2
    • B.1.6
    • C.2.0
    • D.2.6
    Show answer and explanationHide answer

    Correct answer: C. 2.0

    Rearranging CAPM, β = (E(r) − Rf) / (Rm − Rf) = (21% − 5%) / (13% − 5%) = 16% / 8% = 2.0. The 2.6 option 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). The 1.6 option results from an incorrect denominator (e.g., mistakenly using 10% as the premium). The 1.2 option results from dividing the stock's risk premium by the market's total return instead of the market risk premium (16% / 13% ≈ 1.2), forgetting to subtract the risk-free rate in the denominator.

    • A. A beta of 1.2 comes from dividing the stock's 16% risk premium by the market's total 13% return. The denominator should be the 8% market risk premium (13% - 5%). Using 1.2 gives 5% + 1.2 x 8% = 14.6%, not 21%.
    • B. A beta of 1.6 comes from dividing the required return by the market return (21%/13%), which ignores the risk-free rate. Plugging it back in gives 5% + 1.6 x 8% = 17.8%, not the 21% given.
    • C. Required return = Rf + beta(Rm-Rf), so 21% = 5% + beta(13%-5%). That leaves 16% = beta x 8%, so beta = 2.0.
    • D. A beta of about 2.6 comes from dividing the full 21% required return by the 8% market premium (21%/8% = 2.625) without first subtracting the risk-free rate. The risk premium is only 16%, and 2.6 would give 5% + 2.6 x 8% = 25.8%, overshooting 21%.

  2. Question 2, easy

    An active portfolio exceeded its benchmark return by 3.6 percentage points annually over an evaluation period and had 6.0% annualized standard deviation of active returns (tracking error). What information ratio did it deliver?

    • A.0.17.
    • B.0.60.
    • C.1.67.
    • D.9.60.
    Show answer and explanationHide answer

    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.

  3. Question 3, easy

    An investor allocates 60% to a market portfolio (expected return 10%, standard deviation 15%) and 40% to a risk-free asset yielding 3%. What are the expected return and standard deviation of the combined portfolio?

    • A.5.8% and 6.0%
    • B.7.2% and 15.0%
    • C.7.2% and 9.0%
    • D.7.2% and 10.2%
    Show answer and explanationHide answer

    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.

  4. Question 4, medium

    The "efficient frontier" in modern portfolio theory represents:

    • A.The set of portfolios offering the highest expected return for each level of risk (or lowest risk for each level of expected return)
    • B.The single portfolio with the highest possible Sharpe ratio
    • C.A line connecting the risk-free asset to the market portfolio
    • D.The set of all possible portfolios that can be formed from available assets, including inefficient ones
    Show answer and explanationHide answer

    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.

  5. Question 5, easy

    A client inherited a large block of her late father's employer's stock and insists on keeping it, although it is now 45% of her portfolio and she admits she would not buy it today. She cites the sentimental value of the shares. Which behavioral bias best describes her position?

    • A.Overconfidence bias
    • B.Anchoring and adjustment bias
    • C.Endowment bias
    • D.Availability bias
    Show answer and explanationHide answer

    Correct answer: C. Endowment bias

    Endowment bias is an emotional bias in which an investor values an asset more because she owns it, often because it was inherited or has sentimental meaning. Her willingness to hold a stock she would not purchase today is the classic symptom.

    • A. Overconfidence involves overestimating one's own knowledge or skill, which is not what the client describes.
    • B. Anchoring would involve fixating on an initial value or price estimate, not sentimental attachment to ownership.
    • C. Correct. She values the shares more simply because she owns them and inherited them.
    • D. Availability bias involves judging likelihood by how easily examples come to mind, which does not apply here.

  6. Question 6, medium

    A stock has a beta of 1.2. The risk-free rate is 3% and the expected return on the market portfolio is 9%. Using the Capital Asset Pricing Model, the stock's required rate of return is closest to

    • A.9.0%
    • B.7.2%
    • C.13.8%
    • D.10.2%
    Show answer and explanationHide answer

    Correct answer: D. 10.2%

    CAPM required return = risk-free rate + beta × (market return − risk-free rate) = 3% + 1.2 × (9% − 3%) = 3% + 7.2% = 10.2%.

    • A. Incorrect. This simply uses the market return as if beta were 1, ignoring the stock's actual beta of 1.2.
    • B. Incorrect. This is only the risk premium component (beta × market risk premium), omitting the addition of the risk-free rate.
    • C. Incorrect. This results from multiplying beta by the total market return (1.2 × 9% = 10.8%) then adding the risk-free rate incorrectly rather than applying beta to the risk premium only.
    • D. Correct. 3% + 1.2(9% − 3%) = 3% + 7.2% = 10.2%.

  7. Question 7, medium

    How does the capital market line (CML) differ from the security market line (SML)?

    • A.The CML plots expected return against beta and applies to any individual security, while the SML plots expected return against standard deviation and is limited to efficient portfolios
    • B.The CML applies only to efficient portfolios (combinations of the risk-free asset and the market portfolio) plotted against total risk (standard deviation), while the SML applies to any individual security or portfolio plotted against systematic risk (beta)
    • C.The CML and SML are two names for the same relationship, since both plot expected return against total risk and both apply to any individual security or portfolio
    • D.The SML is generally used for portfolios with a beta above 1.0, while portfolios with lower betas are priced using the CML instead
    Show answer and explanationHide answer

    Correct answer: B. The CML applies only to efficient portfolios (combinations of the risk-free asset and the market portfolio) plotted against total risk (standard deviation), while the SML applies to any individual security or portfolio plotted against systematic risk (beta)

    The CML plots expected return against total risk (standard deviation) and is valid only for efficient portfolios that combine the risk-free asset with the market portfolio. The SML plots expected return against systematic risk (beta) and applies to any asset or portfolio, efficient or not, since it isolates only the priced (systematic) component of risk. Choice A reverses the axes of each line, Choice C incorrectly claims they are identical, and Choice D fabricates an arbitrary beta restriction that does not exist.

    • A. Incorrect. This reverses the two lines; the CML plots against standard deviation (total risk) for efficient portfolios, while the SML plots against beta (systematic risk) for any asset.
    • B. Correct. The CML is limited to efficient portfolios combining the risk-free asset and market portfolio, measured against total risk, while the SML applies to any asset or portfolio measured against systematic risk (beta).
    • C. Incorrect. The CML and SML represent different risk-return relationships (total risk vs. systematic risk) with different applicability, so they are not two names for the same line.
    • D. Incorrect. The SML applies across the full range of beta values, including betas below 1.0, and does not hand low-beta portfolios over to the CML.

  8. Question 8, medium

    An investor is adding a second asset to a single-asset portfolio. Holding the expected returns and standard deviations of both assets constant, the risk-reduction benefit of diversification is greatest when the correlation coefficient between the two assets' returns is:

    • A.+1.0
    • B.+0.5
    • C.0.0
    • D.-1.0
    Show answer and explanationHide answer

    Correct answer: D. -1.0

    Portfolio variance depends on the covariance (and thus correlation) between asset returns; the lower the correlation coefficient, the greater the diversification benefit for a given combination of assets. A correlation of −1.0 (perfect negative correlation) provides the maximum possible risk-reduction benefit, in principle allowing portfolio risk to be eliminated entirely with the appropriate weights.

    • A. Wrong. Perfect positive correlation provides no diversification benefit; portfolio risk is simply the weighted average of the individual asset risks.
    • B. Wrong. Positive correlation still provides only limited diversification benefit relative to lower or negative correlations.
    • C. Wrong. Zero correlation does provide a meaningful diversification benefit, but it is not the maximum possible benefit.
    • D. Correct.

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