Investment Strategies Flashcards

A portfolio manager wants to reduce unsystematic risk without reducing expected return. Which strategy best achieves this?

Answer: Diversification across uncorrelated assets

Diversification across uncorrelated assets eliminates unsystematic (company-specific) risk while preserving expected return, per modern portfolio theory.

Under the Capital Asset Pricing Model (CAPM), which factor determines a security's required rate of return?

Answer: The security's beta relative to the market

CAPM uses beta (systematic risk) to determine required return: E(R) = Rf + β(Rm − Rf).

An investor purchases a zero-coupon bond at a deep discount. What is the primary risk this investor faces?

Answer: Interest rate risk due to long duration

Zero-coupon bonds have duration equal to their maturity, making them highly sensitive to interest rate changes.

Which of the following best describes a 'covered call' options strategy?

Answer: Selling a call option while holding the underlying stock

A covered call involves writing (selling) a call option on shares already owned, generating premium income while capping upside.

The Sharpe ratio measures portfolio performance by:

Answer: Dividing excess return by total standard deviation

The Sharpe ratio = (Portfolio Return − Risk-Free Rate) / Portfolio Standard Deviation, measuring return per unit of total risk.

Which investment strategy involves systematically investing equal dollar amounts at regular intervals regardless of price?

Answer: Dollar-cost averaging

Dollar-cost averaging buys more shares when prices are low and fewer when prices are high, reducing average cost over time.

A company has a price-to-earnings ratio of 8x while its industry peers average 15x. A value investor would most likely:

Answer: Consider purchasing the stock as potentially undervalued

Value investors seek stocks trading below intrinsic value; a P/E significantly below peers may indicate an undervalued opportunity.