FA FA Investment Analysis & Portfolio Management 2 — Questions and Answers
Question 1: What does the term 'alpha' represent in investment management?
- Excess return generated above the benchmark after adjusting for risk (Correct answer)
- The portfolio's standard deviation
- The risk-free rate component of total return
- The correlation between two assets
Correct answer: Excess return generated above the benchmark after adjusting for risk
Alpha measures a manager's value-added performance above what would be expected given the portfolio's level of systematic risk.
Question 2: Which fixed-income risk refers to the possibility that a bondholder will be unable to reinvest coupon payments at the original yield?
- Reinvestment risk (Correct answer)
- Credit risk
- Liquidity risk
- Inflation risk
Correct answer: Reinvestment risk
Reinvestment risk arises when interest rates fall after a bond is purchased, forcing coupon reinvestment at lower rates and reducing total return.
Question 3: What does the Price-to-Earnings (P/E) ratio tell an investor about a stock?
- How much investors are willing to pay per dollar of the company's earnings (Correct answer)
- The percentage of earnings paid out as dividends
- The company's total market capitalization relative to debt
- The stock's expected annual return
Correct answer: How much investors are willing to pay per dollar of the company's earnings
The P/E ratio shows the market's valuation of each dollar of earnings; a higher P/E implies investors expect stronger future growth.
Question 4: In Modern Portfolio Theory, the 'efficient frontier' represents portfolios that:
- Offer the maximum expected return for a given level of risk (Correct answer)
- Generate the highest absolute returns regardless of risk
- Minimize taxes on investment income
- Hold only government securities
Correct answer: Offer the maximum expected return for a given level of risk
The efficient frontier is the set of optimal portfolios that maximize expected return at each level of portfolio risk, as defined by Markowitz.
Question 5: Which investment strategy involves buying undervalued stocks trading below their intrinsic value, with a margin of safety?
- Value investing (Correct answer)
- Growth investing
- Momentum investing
- Index investing
Correct answer: Value investing
Value investing, popularized by Benjamin Graham and Warren Buffett, seeks stocks priced below intrinsic value to provide a buffer against analytical errors.
Question 6: What does the current ratio measure in financial statement analysis?
- A company's ability to pay short-term liabilities with short-term assets (Correct answer)
- The percentage of revenue converted into operating income
- The proportion of long-term debt to total assets
- Year-over-year revenue growth rate
Correct answer: A company's ability to pay short-term liabilities with short-term assets
The current ratio (current assets ÷ current liabilities) assesses short-term liquidity; a ratio above 1 indicates the company can cover near-term obligations.
FA FA Investment Analysis & Portfolio Management 2
What does the term 'alpha' represent in investment management?