Investment Principles of Investment 2 — Questions and Answers
Question 1: What does diversification primarily aim to reduce in a portfolio?
- Unsystematic risk (Correct answer)
- Inflation risk
- Interest rate risk
- Market risk
Correct answer: Unsystematic risk
Diversification reduces unsystematic (company-specific) risk by spreading investments across assets.
Question 2: An investor with a 30-year horizon and high risk tolerance would most likely favor which asset class?
- Money market funds
- Equities (Correct answer)
- Treasury bills
- Certificates of deposit
Correct answer: Equities
Equities offer higher long-term growth potential suitable for a long horizon and high risk tolerance.
Question 3: What is the relationship between bond prices and interest rates?
- They move in the same direction
- They are unrelated
- They move in opposite directions (Correct answer)
- Bonds always rise
Correct answer: They move in opposite directions
Bond prices fall when interest rates rise and rise when rates fall, an inverse relationship.
Question 4: Which metric measures a stock's volatility relative to the overall market?
- Alpha
- P/E ratio
- Beta (Correct answer)
- Dividend yield
Correct answer: Beta
Beta measures a security's volatility relative to the broader market, where 1.0 equals market movement.
Question 5: What does dollar-cost averaging involve?
- Investing a lump sum at market lows
- Investing fixed amounts at regular intervals (Correct answer)
- Selling during downturns
- Buying only on dips
Correct answer: Investing fixed amounts at regular intervals
Dollar-cost averaging invests a fixed amount on a regular schedule regardless of price.
Question 6: Compound interest differs from simple interest because it earns interest on:
- Only the principal
- Principal plus accumulated interest (Correct answer)
- Only dividends
- A fixed annual fee
Correct answer: Principal plus accumulated interest
Compound interest earns returns on both the principal and previously accumulated interest.
Question 7: A 'blue-chip' stock typically refers to shares of a company that is:
- Newly listed and speculative
- Large, well-established, and financially sound (Correct answer)
- A penny stock
- About to go bankrupt
Correct answer: Large, well-established, and financially sound
Blue-chip stocks are large, stable, well-established companies with reliable performance.
Investment Principles of Investment 2
What does diversification primarily aim to reduce in a portfolio?