Risk, Return & Investment Performance Flashcards

Which type of risk is eliminated through diversification across many asset classes?

Answer: Unsystematic risk

Unsystematic (idiosyncratic) risk is company- or industry-specific and can be diversified away, unlike systematic risk.

An investment has an arithmetic mean return of 10% and a geometric mean return of 9.5%. What explains the difference?

Answer: Compounding effect of volatility

Volatility causes the geometric mean to be lower than the arithmetic mean; higher variance widens the gap.

A client wants to maximize return for a given level of risk. According to Modern Portfolio Theory, the client should select a portfolio on which boundary?

Answer: Efficient frontier

The efficient frontier represents portfolios offering the highest expected return for each level of portfolio risk.

Which risk measure expresses the maximum expected loss over a given time period at a specified confidence level?

Answer: Value at Risk (VaR)

VaR quantifies the maximum potential loss over a defined period at a given confidence level (e.g., 95% or 99%).

The Capital Asset Pricing Model (CAPM) assumes which of the following?

Answer: All investors can borrow and lend at the risk-free rate

CAPM assumes investors can borrow and lend unlimited amounts at the risk-free rate, among other simplifying assumptions.

Which of the following is an example of a 'real' rate of return calculation?

Answer: 10% nominal return minus 3% inflation = 7% real return (approximate)

The approximate real return = nominal return − inflation rate; the exact Fisher formula refines this calculation.

A portfolio manager consistently earns 2% above benchmark after adjusting for risk. This excess return is known as:

Answer: Alpha

Alpha represents the risk-adjusted excess return generated by a portfolio manager above the expected return from CAPM or a benchmark.