FA FA Investment Analysis & Portfolio Management 1 — Questions and Answers
Question 1: Which theory states that in an efficient market, asset prices reflect all available information?
- Efficient Market Hypothesis (EMH) (Correct answer)
- Modern Portfolio Theory (MPT)
- Capital Asset Pricing Model (CAPM)
- Arbitrage Pricing Theory (APT)
Correct answer: Efficient Market Hypothesis (EMH)
The Efficient Market Hypothesis posits that prices always incorporate all known information, making it impossible to consistently outperform the market through analysis.
Question 2: In the Capital Asset Pricing Model (CAPM), what does beta measure?
- A security's sensitivity to systematic (market) risk (Correct answer)
- The total risk of an individual stock
- A company's dividend growth rate
- The risk-free rate of return
Correct answer: A security's sensitivity to systematic (market) risk
Beta quantifies how much a security's returns move relative to the overall market; a beta of 1 means it moves in line with the market.
Question 3: What is the primary benefit of diversification in a portfolio?
- It reduces unsystematic (company-specific) risk without necessarily sacrificing expected return (Correct answer)
- It eliminates all market risk
- It guarantees higher returns than a concentrated portfolio
- It increases the portfolio's beta
Correct answer: It reduces unsystematic (company-specific) risk without necessarily sacrificing expected return
Diversification reduces idiosyncratic risk by combining assets whose returns do not move perfectly together, lowering overall portfolio volatility.
Question 4: Which bond characteristic measures the weighted average time to receive all cash flows, used to estimate interest rate sensitivity?
- Duration (Correct answer)
- Yield to maturity
- Coupon rate
- Credit spread
Correct answer: Duration
Duration measures a bond's price sensitivity to interest rate changes; a longer duration means greater price volatility when rates move.
Question 5: What is the Sharpe ratio used to measure in portfolio performance evaluation?
- Risk-adjusted return per unit of total portfolio volatility (Correct answer)
- Absolute return over a benchmark index
- The portfolio's correlation with the market
- The maximum drawdown during a specific period
Correct answer: Risk-adjusted return per unit of total portfolio volatility
The Sharpe ratio divides excess return (return minus risk-free rate) by the portfolio's standard deviation to show how much return is earned per unit of risk.
Question 6: Which asset allocation strategy systematically rebalances the portfolio back to target weights as market values drift?
- Strategic asset allocation with periodic rebalancing (Correct answer)
- Tactical asset allocation
- Buy-and-hold strategy
- Momentum investing
Correct answer: Strategic asset allocation with periodic rebalancing
Periodic rebalancing sells outperforming assets and buys underperforming ones to restore the intended risk profile and target allocation.
FA FA Investment Analysis & Portfolio Management 1
Which theory states that in an efficient market, asset prices reflect all available information?