CME-1 Investment Analysis & Portfolio Management 2 — Questions and Answers
Question 1: What is 'Value at Risk' (VaR) used for in portfolio management?
- Measuring average portfolio returns
- Estimating the maximum potential loss over a specific time period at a given confidence level (Correct answer)
- Calculating intrinsic value
- Measuring portfolio alpha
Correct answer: Estimating the maximum potential loss over a specific time period at a given confidence level
VaR estimates the potential loss a portfolio could face within a defined time horizon at a specified confidence level, e.g., 95% one-day VaR of SAR 1 million.
Question 2: Which investment approach focuses on selecting undervalued stocks based on fundamental analysis?
- Technical analysis
- Value investing (Correct answer)
- Momentum investing
- Passive indexing
Correct answer: Value investing
Value investing, associated with Benjamin Graham and Warren Buffett, seeks stocks trading below their intrinsic value using fundamental analysis of financial statements.
Question 3: What is the Sharpe Ratio used to measure?
- Total portfolio return
- Risk-adjusted return: excess return per unit of total risk (standard deviation) (Correct answer)
- Dividend income
- Beta relative to the market
Correct answer: Risk-adjusted return: excess return per unit of total risk (standard deviation)
Sharpe Ratio = (Portfolio Return − Risk-Free Rate) ÷ Standard Deviation. A higher Sharpe Ratio indicates better risk-adjusted performance.
Question 4: What does 'alpha' represent in portfolio performance measurement?
- The portfolio's beta
- Excess return over the benchmark after adjusting for systematic risk (Correct answer)
- Total portfolio volatility
- The risk-free return component
Correct answer: Excess return over the benchmark after adjusting for systematic risk
Alpha measures a portfolio manager's ability to generate returns above the risk-adjusted benchmark; positive alpha indicates outperformance, negative alpha underperformance.
Question 5: What is the difference between active and passive portfolio management?
- No meaningful difference
- Active management attempts to outperform a benchmark through security selection; passive management replicates a benchmark index (Correct answer)
- Passive management uses derivatives; active does not
- Active management is for institutional investors only
Correct answer: Active management attempts to outperform a benchmark through security selection; passive management replicates a benchmark index
Active managers research and select securities attempting to beat the market index, while passive managers replicate an index (e.g., TASI) to match its performance at lower cost.
Question 6: What is the Investment Policy Statement (IPS) used for?
- Filing with the CMA
- Documenting a client's investment objectives, risk tolerance, constraints, and guidelines to direct portfolio management (Correct answer)
- Setting trading limits for brokers
- Annual regulatory compliance filing
Correct answer: Documenting a client's investment objectives, risk tolerance, constraints, and guidelines to direct portfolio management
The IPS is the foundational document for managing a client's portfolio, capturing their goals, risk profile, time horizon, liquidity needs, and legal constraints.
CME-1 Investment Analysis & Portfolio Management 2
What is 'Value at Risk' (VaR) used for in portfolio management?