Portfolio Risk Management Flashcards
6 cards from real Financial Risk Management practice questions. Tap to flip, then mark Knew It or Still Learning — missed cards come back until you master them.
Read the first 6 Portfolio Risk Management flashcards as text
What is the Treynor ratio and how does it differ from the Sharpe ratio?
Answer: The Treynor ratio uses beta (systematic risk) in the denominator instead of total standard deviation, making it useful when a portfolio is part of a larger diversified whole
Treynor = (Rp − Rf) / β; by using beta, it rewards return per unit of systematic risk, which is appropriate when idiosyncratic risk has been diversified away at the fund level.
What is 'Jensen's alpha' in performance attribution?
Answer: The excess return of a portfolio above what CAPM would predict given its beta, measuring the manager's skill
Jensen's alpha = Rp − [Rf + β(Rm − Rf)]; a positive alpha indicates the manager generated returns above the CAPM-predicted risk-adjusted benchmark, suggesting genuine skill.
What does 'maximum drawdown' measure in portfolio risk analysis?
Answer: The largest peak-to-trough decline in portfolio value over a specified period
Maximum drawdown captures the worst cumulative loss from a peak to a subsequent trough, giving a sense of the worst historical pain an investor would have endured holding the portfolio.
What is 'risk budgeting' in portfolio management?
Answer: Allocating the total portfolio risk (e.g., VaR or tracking error) across asset classes, strategies, or managers to reflect desired risk exposures
Risk budgeting shifts the allocation decision from capital dollars to risk units, ensuring that each allocation contributes proportionally to total portfolio risk in line with the investment mandate.
What is a 'factor model' in the context of portfolio risk?
Answer: A model that decomposes portfolio returns and risk into exposures to systematic factors such as market, size, value, momentum, and quality
Factor models (e.g., Fama-French, Barra) decompose risk into systematic factor exposures and idiosyncratic residuals, enabling risk attribution, performance decomposition, and more efficient portfolio construction.
What is 'rebalancing' and why is it important in risk-controlled portfolio management?
Answer: Periodically adjusting portfolio weights back to target allocations to maintain the desired risk profile as asset prices drift
Without rebalancing, winning assets grow to oversized weights, shifting the portfolio's risk profile; regular rebalancing enforces discipline and prevents unintended risk concentrations.
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