Investment Analysis & Portfolio Management Flashcards

What is the primary goal of portfolio diversification?

Answer: To reduce overall portfolio risk

Portfolio diversification involves investing in a variety of assets across different classes, industries, and geographies. The primary goal is to spread risk, so that if one investment performs poorly, others may perform well, offsetting potential losses. This strategy aims to reduce the overall volatility and risk of the portfolio without necessarily sacrificing returns.

What does beta measure in a stock?

Answer: Volatility compared to the market

Beta is a measure of a stock's volatility, or systematic risk, in relation to the overall market. A beta of 1 indicates the stock's price moves with the market, while a beta greater than 1 suggests higher volatility and a beta less than 1 suggests lower volatility. It helps investors understand how much a stock's price is expected to move in response to market changes.

What is the function of the Sharpe ratio?

Answer: To assess risk-adjusted returns

The Sharpe ratio measures the performance of an investment by adjusting for its risk. It calculates the excess return (return above the risk-free rate) per unit of total risk (standard deviation). A higher Sharpe ratio indicates a better risk-adjusted return, meaning the investment is generating more return for the amount of risk taken.

What is considered a defensive stock?

Answer: A stock with stable returns during downturns

A defensive stock refers to a company whose earnings and stock price are relatively stable and tend to hold up well during economic downturns or recessions. These companies typically operate in essential sectors like utilities, consumer staples, or healthcare, providing products and services that people need regardless of the economic climate. They are valued for their consistent performance and lower volatility.

Which of the following is a component of the Capital Asset Pricing Model (CAPM)?

Answer: Risk-free rate

The Capital Asset Pricing Model (CAPM) is a financial model that calculates the expected return on an asset or investment. Its key components include the risk-free rate, which represents the return on an investment with zero risk (e.g., U.S. Treasury bonds), the market risk premium, and the asset's beta. The risk-free rate serves as the baseline return an investor expects for taking no risk.

Which strategy involves regularly adjusting a portfolio to maintain target allocations?

Answer: Rebalancing

Rebalancing is an investment strategy that involves periodically adjusting a portfolio's asset allocation back to its original target weights. For example, if stocks have performed well and now represent a larger portion of the portfolio than intended, rebalancing would involve selling some stocks and buying other assets to restore the desired allocation. This helps manage risk and maintain the portfolio's intended risk-return profile.

Which investment is generally considered the least risky?

Answer: Treasury bills

Treasury bills (T-bills) are short-term debt instruments issued by the U.S. government. They are considered among the safest investments because they are backed by the full faith and credit of the U.S. government, meaning the risk of default is extremely low. Their short maturity also reduces interest rate risk compared to longer-term bonds.

What is the main objective of fundamental analysis?

Answer: To assess intrinsic value using financial data

Fundamental analysis is a method of evaluating a security by attempting to measure its intrinsic value. Analysts examine financial statements, management, industry trends, and economic factors to determine if a company's stock is undervalued or overvalued. The goal is to make informed investment decisions based on the underlying health and prospects of the business, rather than just market price movements.

What does standard deviation indicate in portfolio management?

Answer: The volatility of portfolio returns

In portfolio management, standard deviation is a statistical measure used to quantify the amount of variation or dispersion of a set of data values. When applied to portfolio returns, it indicates the degree to which the returns fluctuate around the average return, thus serving as a common measure of investment risk or volatility. A higher standard deviation implies greater volatility and risk.