Series 65 – Uniform Investment Adviser Law Exam Portfolio Management and Analysis 1 — Questions and Answers
Question 1: What does the Sharpe ratio measure?
- Total return of a portfolio over a specific period
- Risk-adjusted return by dividing excess return over the risk-free rate by the portfolio's standard deviation (Correct answer)
- The correlation between a portfolio and its benchmark index
- The percentage of a portfolio's return attributable to market movements
Correct answer: Risk-adjusted return by dividing excess return over the risk-free rate by the portfolio's standard deviation
The Sharpe ratio measures how much excess return a portfolio earns per unit of total risk (standard deviation), rewarding portfolios that generate more return per unit of risk taken.
Question 2: What is the Capital Asset Pricing Model (CAPM) used to calculate?
- A company's intrinsic value based on future cash flows
- The expected return of an asset based on its systematic risk (beta) relative to the market (Correct answer)
- The optimal allocation between stocks and bonds
- The fair value of an option contract
Correct answer: The expected return of an asset based on its systematic risk (beta) relative to the market
CAPM calculates the expected return of an asset using the risk-free rate, the asset's beta, and the expected market return, establishing a linear relationship between risk and return.
Question 3: What is the efficient frontier in Modern Portfolio Theory?
- The maximum number of securities a portfolio should hold
- The set of optimal portfolios that offer the highest expected return for each level of risk (Correct answer)
- The boundary between domestic and international investments
- The line representing risk-free investment returns
Correct answer: The set of optimal portfolios that offer the highest expected return for each level of risk
The efficient frontier represents the set of portfolios that deliver the maximum expected return for a given level of risk, or minimum risk for a given expected return.
Question 4: What is 'alpha' in portfolio performance measurement?
- A portfolio's total return over a given period
- The excess return of a portfolio above the return predicted by CAPM given its level of systematic risk (Correct answer)
- The volatility of a portfolio relative to the market
- A portfolio's correlation coefficient with its benchmark
Correct answer: The excess return of a portfolio above the return predicted by CAPM given its level of systematic risk
Alpha measures the value an investment manager adds (or subtracts) relative to the return that would be expected given the portfolio's market risk (beta).
Question 5: What does standard deviation measure in the context of investments?
- The average annual return of a portfolio
- The total variability or dispersion of investment returns around the average return (Correct answer)
- The maximum loss a portfolio has experienced
- The correlation between a security and the broad market
Correct answer: The total variability or dispersion of investment returns around the average return
Standard deviation measures the degree to which returns fluctuate around their average, making it a key measure of total investment risk or volatility.
Question 6: Which of the following best describes the concept of 'correlation' in portfolio construction?
- The return generated by adding a new asset to a portfolio
- A statistical measure of how two securities move in relation to each other, ranging from -1 to +1 (Correct answer)
- The degree to which a portfolio matches its benchmark
- The percentage of a portfolio concentrated in a single sector
Correct answer: A statistical measure of how two securities move in relation to each other, ranging from -1 to +1
Correlation measures the degree and direction of the relationship between two securities' returns; a correlation of -1 means they move perfectly opposite, +1 means perfectly together.
