CFM Investment Analysis & Portfolio Management 2 β Questions and Answers
Question 1: A portfolio manager notices that a stock has a beta of 1.5. If the market returns 8% and the risk-free rate is 2%, what is the expected return according to CAPM?
- 9%
- 11%
- 14% (Correct answer)
- 17%
Correct answer: 14%
CAPM: Expected return = 2% + 1.5 Γ (8% β 2%) = 2% + 9% = 11%... wait, 2 + 1.5Γ6 = 2 + 9 = 11%. The correct answer is 11%.
Question 2: Which of the following best describes the Sharpe ratio?
- Excess return per unit of systematic risk
- Excess return per unit of total risk (Correct answer)
- Portfolio return divided by beta
- Standard deviation divided by mean return
Correct answer: Excess return per unit of total risk
The Sharpe ratio measures excess return (above the risk-free rate) per unit of total risk (standard deviation).
Question 3: An investor holds a portfolio with a correlation of 0.3 between two assets. Compared to a correlation of 1.0, what is the primary benefit?
- Higher expected returns
- Greater diversification and lower portfolio variance (Correct answer)
- Reduced systematic risk
- Improved liquidity
Correct answer: Greater diversification and lower portfolio variance
Lower correlation between assets reduces portfolio variance, providing greater diversification benefits.
Question 4: A bond with a duration of 6 years experiences a 50 basis point increase in yield. Approximately what is the percentage change in price?
- -3% (Correct answer)
- -6%
- +3%
- +6%
Correct answer: -3%
Approximate price change = βDuration Γ Ξyield = β6 Γ 0.005 = β3%.
Question 5: Which valuation approach compares a company's metrics to those of similar publicly traded firms?
- Discounted cash flow analysis
- Precedent transaction analysis
- Comparable company analysis (Correct answer)
- Residual income model
Correct answer: Comparable company analysis
Comparable company analysis (comps) values a firm by benchmarking its multiples against peers in the same industry.
Question 6: What does a negative alpha in a portfolio context indicate?
- The portfolio outperformed its benchmark on a risk-adjusted basis
- The portfolio underperformed its benchmark on a risk-adjusted basis (Correct answer)
- The portfolio had negative absolute returns
- The portfolio's beta exceeded 1.0
Correct answer: The portfolio underperformed its benchmark on a risk-adjusted basis
Negative alpha means the portfolio generated less return than expected given its level of risk, indicating underperformance versus the benchmark.
Question 7: In the context of portfolio construction, what is the efficient frontier?
- The set of portfolios with the highest return for any given level of risk (Correct answer)
- The portfolio with the absolute maximum return
- A line connecting risk-free assets to risky portfolios
- The boundary between equity and fixed-income allocations
Correct answer: The set of portfolios with the highest return for any given level of risk
The efficient frontier represents the set of optimal portfolios offering the highest expected return for each level of risk.
CFM Investment Analysis & Portfolio Management 2
A portfolio manager notices that a stock has a beta of 1.5.
If the market returns 8% and the risk-free rate is 2%, what is the expected return according to CAPM?