CPA Investment Strategies 2 — Questions and Answers
Question 1: A portfolio manager wants to reduce unsystematic risk without reducing expected return. Which strategy best achieves this?
- Diversification across uncorrelated assets (Correct answer)
- Investing only in Treasury bonds
- Concentrating in one high-growth sector
- Increasing portfolio beta above 1.5
Correct answer: Diversification across uncorrelated assets
Diversification across uncorrelated assets eliminates unsystematic (company-specific) risk while preserving expected return, per modern portfolio theory.
Question 2: Under the Capital Asset Pricing Model (CAPM), which factor determines a security's required rate of return?
- Standard deviation of the security's returns
- The security's beta relative to the market (Correct answer)
- The security's dividend yield
- The price-to-earnings ratio
Correct answer: The security's beta relative to the market
CAPM uses beta (systematic risk) to determine required return: E(R) = Rf + β(Rm − Rf).
Question 3: An investor purchases a zero-coupon bond at a deep discount. What is the primary risk this investor faces?
- Credit risk from periodic coupon defaults
- Interest rate risk due to long duration (Correct answer)
- Reinvestment risk from high coupon payments
- Currency risk from foreign denominations
Correct answer: Interest rate risk due to long duration
Zero-coupon bonds have duration equal to their maturity, making them highly sensitive to interest rate changes.
Question 4: Which of the following best describes a 'covered call' options strategy?
- Buying a call option without owning the underlying stock
- Selling a call option while holding the underlying stock (Correct answer)
- Buying a put option to hedge a long stock position
- Selling a put option on a stock not currently owned
Correct answer: Selling a call option while holding the underlying stock
A covered call involves writing (selling) a call option on shares already owned, generating premium income while capping upside.
Question 5: The Sharpe ratio measures portfolio performance by:
- Dividing excess return by total standard deviation (Correct answer)
- Dividing excess return by beta
- Multiplying alpha by the information ratio
- Comparing return to a benchmark index
Correct answer: Dividing excess return by total standard deviation
The Sharpe ratio = (Portfolio Return − Risk-Free Rate) / Portfolio Standard Deviation, measuring return per unit of total risk.
Question 6: Which investment strategy involves systematically investing equal dollar amounts at regular intervals regardless of price?
- Value averaging
- Dollar-cost averaging (Correct answer)
- Momentum investing
- Tactical asset allocation
Correct answer: Dollar-cost averaging
Dollar-cost averaging buys more shares when prices are low and fewer when prices are high, reducing average cost over time.
Question 7: A company has a price-to-earnings ratio of 8x while its industry peers average 15x. A value investor would most likely:
- Avoid the stock as it appears financially distressed
- Consider purchasing the stock as potentially undervalued (Correct answer)
- Short-sell the stock expecting further decline
- Hold the stock until P/E converges upward on its own
Correct answer: Consider purchasing the stock as potentially undervalued
Value investors seek stocks trading below intrinsic value; a P/E significantly below peers may indicate an undervalued opportunity.
CPA Investment Strategies 2
A portfolio manager wants to reduce unsystematic risk without reducing expected return.
Which strategy best achieves this?