R02 Approaches to asset allocation: free practice questions
5 free questions on Approaches to asset allocation, part of learning outcome 8 (Investment planning). Pick an answer to check it, or open the answer to see why each option is right or wrong.
Question 1 of 5
What are the two main approaches to asset allocation?
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The answer is D: Theoretical and pragmatic
The theoretical approach uses MPT and mathematical optimisation; the pragmatic approach uses long-run averages and judgement. In practice, most advisers use elements of both.
Why the other options are wrong
A
These are approaches to fund management.
B
These are approaches to portfolio construction.
C
These are investment styles.
Question 2 of 5
Why might a theorist adjust a model's inputs rather than use three years of recent volatility data?
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The answer is C: Short data runs can lead to too much or too little in an asset class
Decisions are about the future, so theorists often use expectations rather than raw history. Short runs of data can distort allocations, so adjusting for mean reversion is common.
Why the other options are wrong
A
Volatility is a key input.
B
It can mislead in either direction.
D
There's no such ban.
Question 3 of 5
Which of the following are recognised weaknesses in the assumptions of portfolio optimisation models?
1. Returns are assumed to be normally distributed
2. Historic data may be a poor guide to the future
3. Rebalancing costs may be unrealistically high or ignored
4. The model guarantees the portfolio will match its benchmark
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The answer is A: 1, 2 and 3 only
Weaknesses include assuming normal distributions, relying on historic data, inaccurate forecasts, unrealistic rebalancing costs and implementation with assets different from those modelled.
Why the other options are wrong
B
Rebalancing costs are also a weakness.
C
No model guarantees benchmark returns; the normality assumption is a weakness.
D
Statement 4 isn't an assumption of these models.
Question 4 of 5
Why do most asset allocation practitioners focus on strategic rather than tactical allocation?
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The answer is A: MPT suggests it isn't possible to time the market
If the client's needs and risk tolerance are correctly specified, there's an ideal allocation. MPT also implies switching between asset classes is as likely to lose as to profit.
Why the other options are wrong
B
It's adjusted if circumstances change.
C
It's allowed but places more responsibility on the adviser.
D
They're as likely to lose as to gain.
Question 5 of 5
Why must a client's risk tolerance be reassessed regularly?
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The answer is B: It usually changes over time
Risk tolerance combines risk perception, often superficial and swayed by recent events, and attitude to risk, formed by background and experience. Assessments are a snapshot, so regular reassessment is essential.
Why the other options are wrong
A
It's assessed for each client, not set by regulators.
C
It does change.
D
There's no expiry; tolerance itself changes.
Practise all 24 Approaches to asset allocation questions
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