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 does 'diversification' mean in the context of portfolio risk management?
Answer: Spreading investments across assets with low or negative correlations to reduce overall portfolio risk without proportionally reducing expected return
Diversification exploits the fact that imperfectly correlated assets do not all lose value simultaneously, so combining them reduces portfolio volatility relative to individual asset volatility.
What is the Sharpe ratio used to measure?
Answer: The risk-adjusted return of a portfolio, calculated as excess return above the risk-free rate divided by portfolio standard deviation
The Sharpe ratio (= (Rp − Rf) / σp) measures how much excess return is earned per unit of total risk, allowing comparison of portfolios with different risk levels.
What is 'systematic risk' (market risk) versus 'idiosyncratic risk' (specific risk)?
Answer: Systematic risk affects all assets and cannot be diversified away; idiosyncratic risk is specific to individual assets and can be reduced through diversification
Systematic risk (beta) stems from macroeconomic factors affecting all assets — it cannot be diversified away. Idiosyncratic risk from individual company events averages out in large portfolios.
What does 'beta' measure in the Capital Asset Pricing Model (CAPM)?
Answer: The sensitivity of an asset's return to movements in the overall market portfolio
A beta of 1 means the asset moves with the market; beta > 1 means amplified market moves; beta < 1 means dampened market moves; beta can be negative for defensive assets.
What is the 'efficient frontier' in modern portfolio theory?
Answer: The set of portfolios that maximize expected return for each level of risk, or equivalently minimize risk for each level of expected return
The efficient frontier represents the optimal trade-off between expected return and risk; rational investors should hold portfolios on this frontier rather than portfolios dominated by higher-return / lower-risk alternatives.
What is 'tracking error' in portfolio management?
Answer: The standard deviation of the difference between a portfolio's return and its benchmark return
Tracking error measures how closely a portfolio follows its benchmark; low tracking error means the portfolio returns closely mirror benchmark returns, high tracking error indicates more active deviation.
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