Investment Tools and Concepts Flashcards
7 cards from real CFA practice questions. Tap to flip, then mark Knew It or Still Learning — missed cards come back until you master them.
Read the first 7 Investment Tools and Concepts flashcards as text
The 'equity risk premium' is best defined as:
Answer: The expected return on equities above the risk-free rate
The equity risk premium is the excess return investors expect from equities over the risk-free rate for bearing additional risk.
Which of the following scenarios demonstrates 'positive convexity' in a bond?
Answer: Price gains more when yields fall than it loses when yields rise by the same amount
Positive convexity means price increases are larger than price decreases for equal yield movements, benefiting the bondholder.
An analyst calculates the free cash flow to equity (FCFE) for a firm. FCFE represents:
Answer: Cash flow available to equity holders after debt obligations and reinvestment needs
FCFE is the cash remaining for equity holders after covering operating expenses, capital expenditures, working capital needs, and net debt payments.
In the context of risk decomposition, 'tracking error' measures:
Answer: Standard deviation of the portfolio's returns minus benchmark returns
Tracking error is the standard deviation of active returns (portfolio return minus benchmark return), measuring how closely a portfolio follows its benchmark.
Which of the following best explains why the yield curve typically slopes upward?
Answer: Investors demand a term premium for holding longer-maturity bonds
Longer maturities carry greater interest rate risk and uncertainty, so investors require a term (liquidity) premium for holding them.
A portfolio manager executes a 'barbell strategy' by holding:
Answer: Large positions in very short-term and very long-term bonds, with nothing in between
A barbell strategy concentrates holdings at the two ends of the maturity spectrum, combining short and long-term bonds.
When computing the weighted average cost of capital (WACC), the cost of debt is adjusted by multiplying by (1 - tax rate) because:
Answer: Interest payments are tax-deductible, reducing the effective cost of debt
Interest expense reduces taxable income, so the after-tax cost of debt equals the pre-tax rate multiplied by (1 - tax rate).