R02 Portfolio construction and fund selection: free practice questions

1. Question 1 of 5

   In a top-down investment management process, what is the last decision made?

   Option A: Which industry sectors to overweight or underweightOption B: What the client's risk profile isOption C: Which stocks to select within the chosen sectorsOption D: How to allocate the portfolio between world regions

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   The answer is C: Which stocks to select within the chosen sectors

   Top-down construction decides allocation across the world's regions, then sector weightings, and finally the stocks within the chosen sectors.

   Why the other options are wrong

   A

   Sectors come before stock selection.

   B

   That's set before portfolio construction.

   D

   That's the first step.

2. Question 2 of 5

   Which investment style seeks businesses worth more than the price the market places on them, often holding them for long periods?

   Option A: GAARPOption B: ValueOption C: MomentumOption D: Contrarian

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   The answer is B: Value

   Value is the oldest style, from Benjamin Graham: in the short run the market is a voting machine, in the long run a weighing machine. Equity income managers often adopt it.

   Why the other options are wrong

   A

   GAARP pays a premium for quality and growth.

   C

   Momentum follows trends in earnings and prices.

   D

   Contrarians go against prevailing opinion.

3. Question 3 of 5

   An adviser treated a client's structured product as low risk and set a higher risk profile for the rest of the portfolio. What must happen when the product matures?

   Option A: The remaining portfolio must be reviewed, as it may now be too riskyOption B: The client must pay CGT on the whole portfolioOption C: Nothing, as the client's risk profile is permanent once setOption D: The proceeds must be reinvested in another structured product

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   The answer is A: The remaining portfolio must be reviewed, as it may now be too risky

   Once the low-risk structured product is redeemed, the residual portfolio may represent a higher risk profile than is appropriate, so it must be reviewed.

   Why the other options are wrong

   B

   Maturity doesn't trigger tax on the rest.

   C

   The overall risk changes when the product is redeemed.

   D

   There's no such requirement.

4. Question 4 of 5

   A fund has a portfolio turnover rate of 100%. What does this mean?

   Option A: Every holding is, in effect, replaced each yearOption B: All the fund's income is paid outOption C: The fund has no transaction costs from trading at allOption D: The fund has doubled in size over the past year

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   The answer is A: Every holding is, in effect, replaced each year

   The higher the PTR, the greater the transaction costs. A few funds have PTRs of 20% or less, but most fall between 50% and 100%. Costs are highest for equity funds.

   Why the other options are wrong

   B

   That's the payout ratio, not turnover.

   C

   High turnover means higher costs.

   D

   Turnover measures trading, not growth.

5. Question 5 of 5

   Which of the following are traps when interpreting fund performance statistics? 1. Funds may be in a sector that isn't their true peer group 2. A fund's aims may have changed over the period 3. Returns alone ignore the risk taken 4. Discrete annual figures hide consistency

   Option A: 1, 2, 3 and 4Option B: 2, 3 and 4 onlyOption C: 1 and 3 onlyOption D: 1, 2 and 3 only

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   The answer is D: 1, 2 and 3 only

   Traps include recent results masking earlier ones, misclassification, changes in fund aims and ignoring risk. A manager can top a sector by taking more risk, so risk-adjusted figures matter.

   Why the other options are wrong

   A

   Discrete figures reveal, rather than hide, consistency.

   B

   Discrete figures help show consistency; misclassification is a trap.

   C

   Changes in fund aims are also a trap.

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