FIA Portfolio Theory & Asset Management 2

Question 1

In the Capital Market Line (CML), what does the y-intercept represent?

Accepted Answer

The risk-free rate of return

Answer

The CML's y-intercept is the risk-free rate, which is the return earned when taking zero risk.

Question 2

Which performance measure divides excess return by the portfolio's beta rather than its standard deviation?

Accepted Answer

Treynor ratio

Answer

The Treynor ratio uses beta (systematic risk) as the denominator, unlike the Sharpe ratio which uses total standard deviation.

Question 3

A portfolio has an expected return of 12%, a standard deviation of 18%, and the risk-free rate is 3%. What is its Sharpe ratio?

Accepted Answer

0.50

Answer

Sharpe ratio = (12% - 3%) / 18% = 9% / 18% = 0.50.

Question 4

What is the primary purpose of the efficient frontier in modern portfolio theory?

Accepted Answer

To identify portfolios that maximize return for each level of risk

Answer

The efficient frontier identifies the set of portfolios offering maximum expected return for a given level of risk.

Question 5

When two assets have a correlation coefficient of -1.0, what is achievable through portfolio construction?

Accepted Answer

Complete elimination of portfolio risk

Answer

Perfect negative correlation (-1.0) allows construction of a portfolio with zero variance at the appropriate weights.

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