Financial Risk Management Portfolio Risk Management 1

Question 1

What does 'diversification' mean in the context of portfolio risk management?

Accepted Answer

Spreading investments across assets with low or negative correlations to reduce overall portfolio risk without proportionally reducing expected return

Answer

Investing only in assets with the highest expected returns

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Allocating equally across all available asset classes regardless of risk

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Concentrating in one asset class to maximize Sharpe ratio

Question 2

What is the Sharpe ratio used to measure?

Accepted Answer

The risk-adjusted return of a portfolio, calculated as excess return above the risk-free rate divided by portfolio standard deviation

Answer

The total return of a portfolio over its benchmark

Answer

The maximum drawdown of a portfolio over a year

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The correlation between a portfolio and its benchmark index

Question 3

What is 'systematic risk' (market risk) versus 'idiosyncratic risk' (specific risk)?

Accepted Answer

Systematic risk affects all assets and cannot be diversified away; idiosyncratic risk is specific to individual assets and can be reduced through diversification

Answer

Systematic risk can be diversified away; idiosyncratic risk cannot

Answer

Both types of risk can be eliminated by holding a large portfolio

Answer

Idiosyncratic risk is the dominant risk in a well-diversified portfolio

Question 4

What does 'beta' measure in the Capital Asset Pricing Model (CAPM)?

Accepted Answer

The sensitivity of an asset's return to movements in the overall market portfolio

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The expected return of an asset given its credit rating

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The standard deviation of an asset's daily returns

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The alpha generated by active portfolio management

Question 5

What is the 'efficient frontier' in modern portfolio theory?

Accepted Answer

The set of portfolios that maximize expected return for each level of risk, or equivalently minimize risk for each level of expected return

Answer

The minimum-variance portfolio for a given expected return target

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The portfolio that achieves the highest absolute return in all market conditions

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The set of portfolios that contain only risk-free assets

Question 6

What is 'tracking error' in portfolio management?

Accepted Answer

The standard deviation of the difference between a portfolio's return and its benchmark return

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The absolute difference between a portfolio's return and the market return

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The number of positions that deviated from the model portfolio

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The total cost of trading errors in a given month