CIMA Risk & Return Analysis 2 — Questions and Answers
Question 1: 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?
- 12.8% (Correct answer)
- 13.0%
- 12.6%
- 14.0%
Correct answer: 12.8%
CAPM: 3% + 1.4 × (10% − 3%) = 3% + 9.8% = 12.8%.
Question 2: Which risk measure captures the possibility that actual returns will be worse than expected, focusing only on downside deviations?
- Semi-variance (Correct answer)
- Standard deviation
- Beta
- Coefficient of variation
Correct answer: Semi-variance
Semi-variance measures only the dispersion of returns below the mean, capturing downside risk exclusively.
Question 3: 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?
- 0.50 (Correct answer)
- 0.70
- 0.45
- 0.60
Correct answer: 0.50
Sharpe ratio = (14% − 4%) / 20% = 10% / 20% = 0.50.
Question 4: When comparing two portfolios with identical Sharpe ratios, an investor seeking to maximize risk-adjusted return per unit of systematic risk should use:
- Treynor ratio (Correct answer)
- Sharpe ratio
- Jensen's alpha
- Information ratio
Correct answer: Treynor ratio
The Treynor ratio uses beta (systematic risk) in the denominator, making it appropriate for evaluating systematic risk-adjusted performance.
Question 5: The correlation coefficient between two assets is −0.3. If both assets have equal weight in a portfolio, which statement is most accurate?
- Portfolio risk is reduced but not eliminated due to less-than-perfect negative correlation. (Correct answer)
- Portfolio risk is completely eliminated because the correlation is negative.
- Portfolio risk equals the weighted average of individual risks.
- Diversification has no effect because the correlation is not −1.
Correct 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.
Question 6: In the context of the Capital Market Line (CML), the slope represents:
- The market price of risk (Sharpe ratio of the market portfolio) (Correct answer)
- The market portfolio's beta
- The risk-free rate of return
- Jensen's alpha of the market
Correct 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.
Question 7: Which of the following best describes unsystematic risk in portfolio theory?
- Firm-specific risk that can be diversified away by holding many assets (Correct answer)
- Market-wide risk that affects all securities simultaneously
- The risk premium required by investors for holding equities
- The variability in returns explained by macroeconomic factors
Correct 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.
CIMA Risk & Return Analysis 2
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?