Portfolio Analysis & Risk Management Flashcards

What is 'diversification' in portfolio management and why is it considered beneficial?

Answer: Spreading investments across different asset classes, sectors, and geographies to reduce unsystematic risk

Diversification involves spreading investments across various asset classes, sectors, and regions so that poor performance in one area is offset by others, reducing unsystematic (company-specific) risk without necessarily sacrificing expected returns.

What is 'beta' as a measure of risk in securities analysis?

Answer: A measure of a security's price volatility relative to the overall market

Beta measures the sensitivity of a security's price movements relative to the broader market; a beta of 1 moves with the market, above 1 is more volatile, and below 1 is less volatile.

What is 'alpha' in the context of investment performance evaluation?

Answer: The excess return of an investment relative to its expected return given its risk (beta)

Alpha represents the excess return a portfolio or security generates above what would be predicted by its beta (systematic risk exposure), measuring the value added by the investment manager's skill.

What is the 'Sharpe ratio' and what does it measure?

Answer: A measure of risk-adjusted return, calculated as excess return above the risk-free rate divided by standard deviation

The Sharpe ratio measures risk-adjusted performance by dividing a portfolio's excess return (above the risk-free rate) by its standard deviation, showing how much return is earned per unit of total risk taken.

What is 'duration' as it relates to bond price sensitivity?

Answer: A measure of a bond's sensitivity to interest rate changes; longer duration means greater price sensitivity

Duration measures how sensitive a bond's price is to changes in interest rates; a bond with a duration of 5 years will fall approximately 5% in price for each 1% rise in interest rates.

What is 'systematic risk' (also called market risk) versus 'unsystematic risk' (also called idiosyncratic risk)?

Answer: Systematic = broad market risk that affects all investments and cannot be diversified away; unsystematic = company-specific risk that can be reduced through diversification

Systematic risk affects the entire market (recessions, inflation, geopolitical events) and cannot be eliminated through diversification; unsystematic risk is specific to a company or industry and can be reduced by holding a diversified portfolio.