Certified Plan Sponsor Professional (CPSP) Practice Exam

What is the primary objective of modern portfolio theory?

1. To maximize returns at any risk level

2. To minimize risk for any projected level of return

3. To invest solely in high-risk stocks

4. To reduce investment fees across all asset classes

The correct answer is: To minimize risk for any projected level of return

The primary objective of modern portfolio theory (MPT) is to minimize risk for any projected level of return. This foundational concept revolves around the idea that investors can construct portfolios that optimize return based on a given level of risk. MPT emphasizes diversification, arguing that holding a mix of assets can lead to a more efficient portfolio, meaning that for a specific return expectation, the portfolio can achieve the lowest possible risk. The theory uses statistical measures such as standard deviation and correlation to assess risk and returns, enabling investors to understand how different assets interact and influence the overall portfolio's volatility. By carefully selecting a combination of asset classes that behave differently under various market conditions, investors can achieve a more stable investment performance. This concept negates the notion of seeking to maximize returns without consideration of risk or solely focusing on high-risk assets, as the ultimate goal is to balance risk and return effectively. Additionally, while reducing investment fees is an important factor in overall returns, it does not encompass the primary strategic focus of MPT, which is centered on managing risk in relation to expected returns.