CME-1 Investment Analysis & Portfolio Management 1 — Questions and Answers
Question 1: What does 'systematic risk' (market risk) mean in investment analysis?
- Risk specific to one company
- Risk inherent to the entire market that cannot be diversified away (Correct answer)
- Risk of currency fluctuation only
- Credit risk of a single issuer
Correct answer: Risk inherent to the entire market that cannot be diversified away
Systematic risk affects all securities in the market simultaneously (e.g., recessions, interest rate changes) and cannot be eliminated through diversification.
Question 2: What is the Capital Asset Pricing Model (CAPM) used for?
- Calculating book value of assets
- Estimating the expected return of an asset based on its beta and market risk premium (Correct answer)
- Valuing bonds
- Assessing liquidity risk
Correct answer: Estimating the expected return of an asset based on its beta and market risk premium
CAPM determines the expected return of an asset: Expected Return = Risk-Free Rate + Beta × (Market Return − Risk-Free Rate), linking risk to required return.
Question 3: What does a beta of 1.5 indicate about a stock?
- The stock moves opposite to the market
- The stock is expected to move 1.5 times the market's percentage change in the same direction (Correct answer)
- The stock has no systematic risk
- The stock underperforms the market always
Correct answer: The stock is expected to move 1.5 times the market's percentage change in the same direction
A beta of 1.5 means the stock is 50% more volatile than the market; when the market rises 10% the stock tends to rise 15%, and vice versa.
Question 4: What is the Price-to-Earnings (P/E) ratio used for in equity analysis?
- Measuring dividend yield
- Comparing market price to earnings per share to assess relative valuation (Correct answer)
- Assessing debt levels
- Calculating return on equity
Correct answer: Comparing market price to earnings per share to assess relative valuation
The P/E ratio = Market Price ÷ Earnings Per Share. A higher P/E may indicate growth expectations or overvaluation; a lower P/E may signal value or declining prospects.
Question 5: What is 'duration' in fixed income analysis?
- The maturity date of a bond
- A measure of a bond's price sensitivity to changes in interest rates (Correct answer)
- The coupon payment frequency
- The credit rating of the bond
Correct answer: A measure of a bond's price sensitivity to changes in interest rates
Duration measures how much a bond's price changes for a given change in interest rates; a higher duration means greater interest rate sensitivity.
Question 6: What is the efficient frontier in portfolio theory?
- The maximum possible return regardless of risk
- The set of optimal portfolios offering the highest expected return for a given level of risk (Correct answer)
- The risk-free rate boundary
- The minimum risk portfolio only
Correct answer: The set of optimal portfolios offering the highest expected return for a given level of risk
The efficient frontier represents the optimal risk-return combinations; portfolios on the frontier maximise return for a given risk level or minimise risk for a given return.
CME-1 Investment Analysis & Portfolio Management 1
What does 'systematic risk' (market risk) mean in investment analysis?