Risk & Return Analysis Flashcards

An investor holds a portfolio with a beta of 1.4. If the expected market return is 10% and the risk-free rate is 3%, what is the required return according to CAPM?

Answer: 12.8%

CAPM: 3% + 1.4 × (10% − 3%) = 3% + 9.8% = 12.8%.

Which risk measure captures the possibility that actual returns will be worse than expected, focusing only on downside deviations?

Answer: Semi-variance

Semi-variance measures only the dispersion of returns below the mean, capturing downside risk exclusively.

A portfolio has an expected return of 14% and a standard deviation of 20%. The risk-free rate is 4%. What is the Sharpe ratio?

Answer: 0.50

Sharpe ratio = (14% − 4%) / 20% = 10% / 20% = 0.50.

When comparing two portfolios with identical Sharpe ratios, an investor seeking to maximize risk-adjusted return per unit of systematic risk should use:

Answer: Treynor ratio

The Treynor ratio uses beta (systematic risk) in the denominator, making it appropriate for evaluating systematic risk-adjusted performance.

The correlation coefficient between two assets is −0.3. If both assets have equal weight in a portfolio, which statement is most accurate?

Answer: Portfolio risk is reduced but not eliminated due to less-than-perfect negative correlation.

Negative correlation reduces portfolio variance, but only a correlation of −1 with appropriate weights eliminates risk entirely.

In the context of the Capital Market Line (CML), the slope represents:

Answer: The market price of risk (Sharpe ratio of the market portfolio)

The CML slope equals (Rm − Rf) / σm, which is the market Sharpe ratio and the reward per unit of total risk.

Which of the following best describes unsystematic risk in portfolio theory?

Answer: Firm-specific risk that can be diversified away by holding many assets

Unsystematic (idiosyncratic) risk is company-specific and diminishes as the number of holdings in a portfolio increases.