Free CISI CMP Sec/Deriv Practice Questions: Securities: Investment Management

CISI means Chartered Institute for Securities & Investment. CMP means Capital Markets Programme, and this page is for the Securities/Derivatives unit. Use this focused CISI CMP Securities/Derivatives page as a short practice test for Securities: Investment Management. The items are original Finance Prep sample exam questions built for scenario-based practice, not trivia, puzzle questions, official CISI questions, copied live-exam content, or exam dumps.

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Sample questions

These are original Finance Prep practice questions aligned to this topic area. They are not official CISI questions, copied live-exam content, or exam dumps. Use them to preview question style and explanation depth before continuing with topic drills, mixed sets, and timed mock exams in Finance Prep.

Question 1

Topic: Securities: Investment Management

An institutional balanced fund has a mandate stating:

• Equity exposure must be between 55% and 65%, using the quarter’s measured average exposure.
• Gross quarterly performance is satisfactory only if the portfolio exceeds the benchmark by at least 0.50 percentage points.

Quarter data:

Which assessment should the investment committee make?

• A. The portfolio met both requirements because its gross return exceeded the benchmark and both asset classes had positive returns.
• B. The portfolio should be assessed against its absolute 3.10% gross return only, so no benchmark or constraint conclusion is needed.
• C. The portfolio failed the relative performance target but complied with the equity-exposure constraint.
• D. The portfolio met the relative performance target but breached the equity-exposure constraint.

Best answer: D

What this tests: Securities: Investment Management

Explanation: A benchmark gives the reference point for judging whether a manager added value relative to the agreed market exposure. Here, the portfolio return is 70% × 4.0% plus 30% × 1.0%, or 3.10%. The benchmark return is 60% × 3.5% plus 40% × 1.0%, or 2.50%. The active return is therefore +0.60 percentage points, which exceeds the required +0.50 percentage points. However, performance is not the only test. A mandate also sets constraints that control how the result may be achieved. The manager’s 70% equity exposure is outside the permitted 55% to 65% range, so the portfolio breached the mandate even though it outperformed the benchmark.

• Positive asset-class returns do not prove mandate compliance; exposure limits must also be checked.
• The relative return target was met because active return was +0.60 percentage points, not below target.
• Absolute return alone is insufficient for an institutional mandate that specifies a benchmark and constraints.

The weighted gross return was 3.10% versus a 2.50% benchmark return, but 70% equity exposure exceeded the 65% mandate limit.

Question 2

Topic: Securities: Investment Management

A sterling-based investment manager reviews a one-year holding in a USD-denominated share and related risk notes.

Trade and forecast data:

Spot rates are quoted as USD per GBP. The dividend and sale proceeds are converted at the year-end spot rate.

Risk notes:

• A risk report gives annual standard deviation of returns as 18%.
• The manager separately monitors only losses below the target return.
• The share’s bid-offer spread widened during stressed trading because market depth fell.
• The issuer’s listed bonds were downgraded because of concerns about repayment capacity.

Which statement correctly classifies the returns and risks?

• A. The forecast +10% is volatility; the realised sterling return is about 10%; below-target loss monitoring is liquidity risk; wider spreads, repayment concerns, and the USD/GBP move indicate downside, currency, and credit risk.
• B. The forecast +10% is expected return; the realised sterling return is about 0%; 18% standard deviation is credit risk; below-target loss monitoring is volatility; wider spreads, repayment concerns, and the USD/GBP move indicate liquidity, downside, and credit risk.
• C. The forecast +10% is realised return; the realised sterling return is about 8%; 18% standard deviation is downside risk; wider spreads, repayment concerns, and the USD/GBP move indicate credit, liquidity, and currency risk.
• D. The forecast +10% is expected return; the realised sterling return is about 0%; 18% standard deviation is volatility; below-target loss monitoring is downside risk; wider spreads, repayment concerns, and the USD/GBP move indicate liquidity, credit, and currency risk.

Best answer: D

What this tests: Securities: Investment Management

Explanation: Expected return is a forward-looking estimate, while realised return is measured after the event using actual cash flows. The initial sterling cost is USD 100 divided by 1.25, or £80. The final cash received is USD 106 sale proceeds plus USD 2 dividend, or USD 108; divided by 1.35, this is also £80. The realised sterling return is therefore about 0%, even though the local USD return is 8%, because the exchange-rate move offset the USD gain. Volatility is dispersion of returns, commonly measured by standard deviation. Downside risk focuses specifically on adverse or below-target outcomes. A widened bid-offer spread and reduced market depth indicate liquidity risk. Repayment concerns indicate credit risk. The change in the USD/GBP rate indicates currency risk.

• Treating the forecast as realised return ignores that it was made before the investment.
• Using the 8% USD return for a sterling investor ignores conversion at the year-end spot rate.
• Standard deviation measures volatility across the return distribution, not just downside outcomes.
• Wide bid-offer spreads, repayment capacity, and exchange-rate movement point to liquidity, credit, and currency risk respectively.

Initial and final sterling values are both £80 per share, and the listed risk indicators match their standard meanings.

Question 3

Topic: Securities: Investment Management

A securities analyst is comparing two UK equity mandates for a sterling investor who wants market-like exposure over five years with low implementation drag.

Relevant facts:

• The account is outside a tax wrapper; assume realised gains and cash income are taxed when they arise.
• Mandate A tracks the FTSE All-Share with an ongoing charge of 0.07%, annual turnover of 5%, tracking error of 0.15%, and trades mainly in highly liquid large-cap shares.
• Mandate B is a high-conviction active mandate with a management fee of 0.85%, annual turnover of 95%, tracking error of 6.0%, and a 15% allocation to less liquid small-cap shares with wider spreads.

Which assessment is best?

• A. Mandate B is likely to produce benchmark-like returns because active trading reduces tracking error over time.
• B. Mandate A is guaranteed to outperform because low charges and low tracking error remove liquidity risk and tax drag.
• C. Mandate A is likely to have lower expected drag and closer benchmark outcomes, while Mandate B must earn enough excess return to overcome higher charges, dealing costs, liquidity costs, tracking error, and tax drag.
• D. Mandate B is likely to be more tax-efficient because high turnover gives the manager more chances to realise gains and reinvest the proceeds.

Best answer: C

What this tests: Securities: Investment Management

Explanation: Investor outcomes depend on more than headline gross performance. Ongoing charges directly reduce returns, while high turnover can add dealing commissions, bid-offer spread costs and market impact. In a taxable account, frequent realisation of gains or income can create tax drag by reducing the amount left to compound. Tracking error measures how far returns may deviate from the benchmark, not whether the manager will add value. Less liquid holdings can also increase implementation costs, especially when entering or exiting positions. Mandate A better matches the stated aim of low-drag, market-like exposure. Mandate B may still outperform if manager skill is sufficient, but the higher fee, turnover, liquidity cost and tax burden create a larger hurdle before the investor benefits.

• High turnover does not automatically improve tax efficiency; it can accelerate taxable gains and add dealing costs.
• Active trading does not reduce tracking error; concentrated active positions usually increase benchmark deviation.
• Low charges and low tracking error reduce drag and uncertainty, but they do not eliminate tax, liquidity risk, or the possibility that an active mandate outperforms.

The facts point to lower explicit and implicit costs, lower turnover, lower tax drag, and lower benchmark deviation for Mandate A.

Question 4

Topic: Securities: Investment Management

A trainee analyst reviews a proposed change for an equity client and must comment on the risk impact.

Portfolio note:

• Current holding: 100% invested in one listed UK housebuilder.
• Proposed holding: 30 listed shares across banking, utilities, healthcare, technology, consumer goods, and industrials.
• Geographic exposure: UK, US, and continental Europe.
• Asset allocation: remains fully invested in equities; no cash, bonds, options, or futures are added.

Which interpretation is best supported by the portfolio note?

• A. The proposal will mainly reduce market risk because geographic diversification removes exposure to global equity cycles.
• B. The proposal will not affect risk because all the investments remain ordinary shares.
• C. The proposal should eliminate both company-specific risk and the risk of a general equity market fall.
• D. The proposal should reduce issuer- and sector-specific risk, but the portfolio will still be exposed to broad equity market movements.

Best answer: D

What this tests: Securities: Investment Management

Explanation: Diversification works best against unsystematic risk: risks specific to an individual company, industry, or narrow group of securities. Moving from one housebuilder share to a portfolio of 30 shares across sectors and regions should reduce the impact of one issuer’s poor results or one sector’s downturn. It does not eliminate systematic or market risk. Because the proposed portfolio remains fully invested in equities, it can still be affected by broad factors such as recessions, interest-rate changes, inflation expectations, credit conditions, or a general fall in equity markets. Geographic spread may help reduce exposure to a single domestic market, but global equity markets can still move together during major market events.

• Eliminating both company-specific and market risk overstates what diversification can do.
• Saying risk is unchanged ignores the reduction in concentration risk from holding more issuers and sectors.
• Treating geographic spread as removal of market risk confuses narrower country risk with broad equity market exposure.

Diversifying across issuers, sectors, and regions reduces unsystematic risk, while remaining fully invested in equities leaves market risk in place.

Question 5

Topic: Securities: Investment Management

An investment committee is reviewing how to invest a £20 million long-term allocation.

Mandate facts:

• Objective: obtain broad UK equity market exposure in line with the FTSE All-Share over at least five years.
• Risk profile: willing to accept equity market risk, but wants to avoid concentrated manager-specific risk.
• Constraint: no gearing and no derivatives in the portfolio mandate.
• Evidence reviewed: recent active UK equity mandates have underperformed the benchmark after fees, and the committee has a tight ongoing cost budget.

Which investment approach is the single best fit?

• A. Use leveraged FTSE equity futures to create enhanced market exposure with lower initial cash outlay.
• B. Switch the allocation to an investment-grade sterling corporate bond fund for lower volatility and income.
• C. Appoint a concentrated active UK equity manager with a performance-fee structure.
• D. Invest through a low-cost physical UK equity index fund benchmarked to the FTSE All-Share.

Best answer: D

What this tests: Securities: Investment Management

Explanation: An investment approach should be judged against the mandate’s objective, permitted risk, constraints, and supporting evidence. Here, the stated aim is broad UK equity exposure against a specific equity benchmark, not income generation or benchmark outperformance. A low-cost physical index fund provides diversified exposure close to the FTSE All-Share while reducing stock-selection and manager-style risk. It also aligns with the evidence that active mandates have struggled after fees and with the committee’s tight cost budget. Because the mandate prohibits derivatives and gearing, approaches using futures or leveraged instruments are unsuitable even if they could create equity exposure.

• A concentrated active manager conflicts with the desire to avoid manager-specific risk and is hard to justify given the after-fee underperformance evidence.
• Leveraged futures breach the no-gearing and no-derivatives constraints.
• A sterling corporate bond fund may reduce volatility, but it does not meet the objective of broad UK equity market exposure.

A physical index fund matches the benchmark-led objective, avoids leverage and derivatives, limits manager-specific risk, and supports the cost constraint.

Question 6

Topic: Securities: Investment Management

An investor places £100,000 into a global equity fund for one year.

Use a simple estimate: treat the percentage effects as additive, apply the entry liquidity cost to the initial amount, and ignore compounding and investor-level tax.

Which end-year value is closest?

• A. Approximately £104,900
• B. Approximately £106,200
• C. Approximately £105,800
• D. Approximately £107,000

Best answer: A

What this tests: Securities: Investment Management

Explanation: Investor outcomes should be assessed after implementation frictions, not only against the benchmark return. The benchmark earned 7.0%, but the fund was 0.8 percentage points behind due to realised tracking-error risk. Ongoing charges, turnover-related dealing costs and tax drag reduce return by a further 1.2 percentage points, leaving about 5.0% before the entry spread. The 0.1% liquidity spread reduces the initial £100,000 to £99,900; applying about 5.0% gives £104,895, rounded to £104,900. Equivalently, a simple additive estimate gives a net gain of about 4.9%. Tracking error is not a stated fee, but it can still affect the investor because the fund may not match the benchmark outcome.

• The £107,000 estimate uses only the benchmark return and ignores all specified drags.
• The £106,200 estimate allows for the tracking shortfall but ignores charges, turnover costs, tax drag and liquidity cost.
• The £105,800 estimate deducts charge, turnover and tax effects, but ignores the realised tracking shortfall and entry spread.

It deducts the specified tracking shortfall, charge, turnover costs, tax drag and entry liquidity spread from the benchmark return.

Question 7

Topic: Securities: Investment Management

A UK investor has £250,000 available to invest.

Investor constraints:

• Income need: £10,000 per year from the portfolio for the next 3 years, paid from capital or income.
• Liquidity need: £40,000 must be available in 2 years for a planned house deposit.
• Time horizon: money not needed for these items can remain invested for at least 10 years.
• Risk tolerance: moderate; the investor can accept some market volatility but wants to avoid forced sales of risky assets to meet known cash needs.

Which initial investment approach best matches these constraints?

• A. Hold £40,000 in cash for the house deposit and invest £210,000 in long-dated high-yield bonds for income.
• B. Hold about £70,000 in cash or short-dated high-quality instruments and invest the remaining £180,000 in a diversified moderate-risk portfolio.
• C. Invest the full £250,000 in a global equity fund to maximise the 10-year growth opportunity.
• D. Hold the full £250,000 in cash deposits until all income and liquidity needs have passed.

Best answer: B

What this tests: Securities: Investment Management

Explanation: Known near-term cash requirements should normally be matched with liquid, low-volatility assets before taking investment risk with the remaining capital. Here, the investor needs £10,000 per year for 3 years, or £30,000, plus £40,000 in 2 years for the house deposit. That totals £70,000. Placing roughly this amount in cash, money-market instruments, or short-dated high-quality bonds reduces the risk of having to sell volatile assets at an unfavourable time. The remaining £180,000 has a 10-year horizon and can be invested in a diversified moderate-risk portfolio, consistent with the investor’s risk tolerance and growth/income needs.

• A full equity allocation ignores the income and liquidity needs due within 3 years.
• Holding everything in cash protects liquidity but is too conservative for the capital with a 10-year horizon and moderate risk tolerance.
• Setting aside only the house deposit ignores the separate £30,000 income requirement and long-dated high-yield bonds add credit and interest-rate risk.

The known 3-year income need plus the 2-year liquidity need totals £70,000, leaving the balance available for longer-term diversified investment.

Question 8

Topic: Securities: Investment Management

A portfolio manager is reviewing four institutional mandates. Ignore investment income and fees.

Which client has the strongest immediate liquidity requirement to reflect in portfolio construction, based on next year’s estimated net cash flow as a percentage of assets?

• A. The permanent charity endowment, because its grant programme is 4% of assets.
• B. The closed defined benefit pension scheme, because its net outflow is 5% of assets.
• C. The life insurer annuity book, because its net outflow is 12% of assets.
• D. The university endowment, because its gross spending is 3% of assets.

Best answer: C

What this tests: Securities: Investment Management

Explanation: Institutional investment management starts with the nature and timing of the investor’s liabilities or spending commitments. Here, the relevant estimate is net cash flow as a percentage of invested assets. The life insurer expects £80m of claims and annuity payments and £20m of premiums, giving a £60m net outflow. Against £500m of assets, that is 12%. This is higher than the closed pension scheme’s 5% net outflow and the university endowment’s 2% net outflow. The charity endowment has a net inflow, not an outflow. A life insurer with significant predictable payments normally gives high priority to liquidity, asset-liability matching, credit quality and regulatory capital constraints.

• The pension scheme has a meaningful net outflow, but £40m on £800m is only 5%.
• The charity’s grants should be assessed net of donations; it has a £1m net inflow.
• The university endowment’s gross spending is not the best measure; net outflow is £5m, or 2% of assets.

The insurer has the largest net cash outflow relative to assets, so liquidity and liability cash-flow matching are the most pressing considerations.

Question 9

Topic: Securities: Investment Management

An equity portfolio is built using a rules-based screen rather than analyst forecasts.

• Universe: four shares from a benchmark index.
• Monthly rule: calculate a composite score for each share as dividend yield plus earnings yield.
• Portfolio construction: if only one share can be selected this month, buy the highest-scoring share; do not hold benchmark market-cap weights.
• No manager override is allowed.

Which result and investment approach best fit the rule?

• A. Gamma; passive index-tracking approach.
• B. Delta; growth-focused investment approach.
• C. Beta; income-focused investment approach.
• D. Alpha; factor-based investment approach.

Best answer: D

What this tests: Securities: Investment Management

Explanation: A factor-based approach selects securities using measurable characteristics, such as yield, value, momentum, quality, or size, often through a repeatable rule. Here the scores are Alpha 10%, Beta 8%, Gamma 9%, and Delta 7%, so Alpha is selected. The portfolio is not passive because it does not replicate benchmark market-cap weights. It is not simply income-focused because the rule combines dividend yield with earnings yield rather than choosing only the highest dividend payer. It is not growth-focused because no revenue or earnings growth forecast is used. The absence of manager override also points away from discretionary active stock picking, even though the result will differ from the benchmark.

• Beta has the highest dividend yield, but the rule uses a combined score, so it is not a pure income approach.
• Gamma is in the benchmark universe, but selecting it would not replicate benchmark weights, so it is not passive index tracking.
• Delta has the lowest composite score and no supplied growth metric supports a growth-focused classification.

Alpha has the highest composite score at 10%, and the mechanical use of defined share characteristics is a factor-based approach.

Question 10

Topic: Securities: Investment Management

An investment committee is considering replacing a passive UK equity holding with an active fund for a five-year growth mandate.

Portfolio facts:

• Amount invested: £500,000
• Passive holding return over the last three months: 2.2%
• Proposed active fund return over the last three months: 2.8%
• One-off dealing and bid-offer cost to switch: 0.50% of the portfolio
• Ignore tax and assume no ongoing fee difference.

Which assessment is most appropriate?

• A. Switch because the return gap is 0.6 percentage points and already exceeds the 0.50% switch cost, proving the decision is economical.
• B. Treat the 0.6% excess return (£3,000) as short-term evidence only; after a £2,500 switch cost it is not enough, by itself, to support a five-year decision.
• C. Reject the active fund because 0.6% of £500,000 is only £300, which is immaterial relative to the switch cost.
• D. Switch because the 0.6% quarterly excess annualises to about 2.4%, demonstrating a persistent long-term advantage.

Best answer: B

What this tests: Securities: Investment Management

Explanation: The active fund outperformed by 0.6 percentage points over three months. On £500,000, that is £3,000 before costs. The one-off switching cost is 0.50%, or £2,500, leaving only a small apparent short-term benefit. More importantly, a three-month return is not strong evidence for a five-year investment decision. Short periods can be heavily affected by market style, sector exposure, luck, or temporary conditions. A long-term mandate should consider a fuller performance record, risk taken, consistency, process, costs, and suitability for the portfolio objective rather than relying on one recent quarter.

• Annualising a three-month excess return assumes the short-term pattern will persist, which is not reliable evidence.
• The calculation that 0.6% of £500,000 equals £300 is incorrect; it equals £3,000.
• Beating the switch cost over one short period does not prove that switching is justified for a five-year mandate.

The active fund’s small three-month excess return only marginally exceeds the switching cost and is too short a record to justify a long-term allocation on performance alone.

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