AAMS Risk, Return & Investment Performance 2 — Questions and Answers
Question 1: A portfolio has a standard deviation of 12% and the market standard deviation is 10%. The correlation between the portfolio and market is 0.8. What is the portfolio's beta?
- 0.80
- 0.96 (Correct answer)
- 1.20
- 1.50
Correct answer: 0.96
Beta = (portfolio std dev / market std dev) × correlation = (12/10) × 0.8 = 0.96.
Question 2: Which performance metric penalizes a portfolio manager only for downside volatility, not total volatility?
- Sharpe ratio
- Treynor ratio
- Sortino ratio (Correct answer)
- Jensen's alpha
Correct answer: Sortino ratio
The Sortino ratio uses downside deviation in the denominator rather than total standard deviation.
Question 3: An investor's portfolio returned 9% while the benchmark returned 7%. The portfolio's tracking error was 3%. What is the information ratio?
- 0.47
- 0.67 (Correct answer)
- 1.29
- 3.00
Correct answer: 0.67
Information ratio = active return / tracking error = (9% − 7%) / 3% = 0.67.
Question 4: When comparing two portfolios with different betas, which measure is most appropriate for evaluating risk-adjusted performance?
- Standard deviation
- Sharpe ratio
- Treynor ratio (Correct answer)
- Coefficient of variation
Correct answer: Treynor ratio
The Treynor ratio uses beta as the risk measure, making it ideal for comparing portfolios with different levels of systematic risk.
Question 5: A bond's duration is 6 years and interest rates rise by 1%. Approximately what happens to the bond's price?
- Rises by 6%
- Falls by 6% (Correct answer)
- Rises by 1%
- Falls by 1%
Correct answer: Falls by 6%
Using the duration approximation, price change ≈ −duration × Δy = −6 × 1% = −6%.
Question 6: Which of the following best describes the 'risk premium' in the context of expected returns?
- The rate earned on a 90-day T-bill
- The extra return above the risk-free rate demanded by investors (Correct answer)
- The cost of insuring against portfolio losses
- The volatility of returns above the mean
Correct answer: The extra return above the risk-free rate demanded by investors
The risk premium is the additional expected return investors require above the risk-free rate to compensate for bearing risk.
Question 7: Portfolio A has a Sharpe ratio of 1.2 and Portfolio B has a Sharpe ratio of 0.9. Which conclusion is most accurate?
- Portfolio A has higher absolute returns
- Portfolio A provides better risk-adjusted return per unit of total risk (Correct answer)
- Portfolio B has lower systematic risk
- Portfolio A has a higher beta than Portfolio B
Correct answer: Portfolio A provides better risk-adjusted return per unit of total risk
A higher Sharpe ratio means more excess return per unit of total (standard deviation) risk, not necessarily higher absolute returns.
AAMS Risk, Return & Investment Performance 2
A portfolio has a standard deviation of 12% and the market standard deviation is 10%.
The correlation between the portfolio and market is 0.8.
What is the portfolio's beta?