CFE Investment & Portfolio Management Flashcards

Which investment principle states that higher potential returns are associated with higher levels of risk?

Answer: Risk-return tradeoff

The risk-return tradeoff is a fundamental investment concept stating that the potential return on an investment increases proportionally with an increase in risk.

What does the Sharpe Ratio measure in portfolio management?

Answer: Risk-adjusted return relative to a risk-free rate

The Sharpe Ratio measures the excess return per unit of risk, calculated as (portfolio return minus risk-free rate) divided by portfolio standard deviation.

Which type of risk can be eliminated through portfolio diversification?

Answer: Unsystematic (idiosyncratic) risk

Unsystematic risk, also called idiosyncratic or specific risk, is company-specific and can be reduced or eliminated by holding a diversified portfolio.

A financial examiner reviews a bank's investment portfolio and finds heavy concentration in a single sector. This primarily violates which best practice?

Answer: Diversification

Concentration in a single sector violates diversification best practices, which require spreading investments to reduce exposure to any one area.

What is the primary purpose of an Investment Policy Statement (IPS) in a financial institution?

Answer: To document investment objectives, guidelines, and constraints

An IPS documents an institution's investment objectives, risk tolerance, time horizon, and constraints to guide portfolio management decisions.

Which bond characteristic measures its sensitivity to changes in interest rates?

Answer: Duration

Duration measures a bond's price sensitivity to interest rate changes; a higher duration means greater price volatility when rates shift.