Financial Advisor Investment Planning and Portfolio Management 1 — Questions and Answers
Question 1: Which investment theory states that rational investors should hold efficient portfolios that maximize return for a given level of risk?
- Efficient Market Hypothesis
- Modern Portfolio Theory (MPT) (Correct answer)
- Capital Asset Pricing Model
- Arbitrage Pricing Theory
Correct answer: Modern Portfolio Theory (MPT)
Modern Portfolio Theory, developed by Harry Markowitz, holds that investors can construct efficient portfolios maximizing expected return for a given level of risk through diversification.
Question 2: In the Capital Asset Pricing Model (CAPM), what does a beta of 1.5 indicate about a security?
- It is 50% less volatile than the market
- It moves 1.5 times the market's movements in the same direction (Correct answer)
- It has a 1.5% expected return
- It is inversely correlated with the market
Correct answer: It moves 1.5 times the market's movements in the same direction
A beta of 1.5 means the security is expected to move 1.5 times as much as the benchmark market index, indicating higher systematic risk.
Question 3: Which asset allocation strategy automatically rebalances a portfolio to maintain a constant stock-to-bond ratio?
- Tactical asset allocation
- Strategic asset allocation (Correct answer)
- Constant-proportion portfolio insurance (CPPI)
- Dynamic asset allocation
Correct answer: Strategic asset allocation
Strategic asset allocation sets long-term target weights and rebalances periodically to maintain that constant mix regardless of market conditions.
Question 4: What is the Sharpe ratio used to measure in portfolio analysis?
- Total portfolio return
- Risk-adjusted return per unit of total risk (Correct answer)
- The correlation between two assets
- A portfolio's exposure to interest rate risk
Correct answer: Risk-adjusted return per unit of total risk
The Sharpe ratio measures risk-adjusted performance by dividing excess return (above the risk-free rate) by the portfolio's standard deviation.
Question 5: Dollar-cost averaging is best described as:
- Investing a lump sum at market lows
- Investing equal dollar amounts at regular intervals regardless of price (Correct answer)
- Rebalancing to equal dollar weights across all holdings
- Averaging down by buying more shares as prices fall
Correct answer: Investing equal dollar amounts at regular intervals regardless of price
Dollar-cost averaging involves investing a fixed dollar amount at regular intervals, resulting in purchasing more shares when prices are low and fewer when prices are high.
Question 6: Which type of risk CANNOT be eliminated through diversification?
- Business risk
- Liquidity risk
- Systematic (market) risk (Correct answer)
- Default risk
Correct answer: Systematic (market) risk
Systematic risk, also called market risk, affects all securities and cannot be diversified away because it stems from economy-wide factors.
Financial Advisor Investment Planning and Portfolio Management 1
Which investment theory states that rational investors should hold efficient portfolios that maximize return for a given level of risk?