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CFP Exam > CFP Investments - Portfolio Theory > Flashcards

CFP Investments - Portfolio Theory Flashcards

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1
Q

Definition of Standard Deviation

A

A measure of risk and variability of returns

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2
Q

The higher the standard deviation, the

A

higher the riskiness of the investment

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3
Q

+/- 1, 2, 3 standard deviation percentages

A

+-/ 1: 68%

+-/ 2: 95%

+-/ 3: 99%

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4
Q

Coefficient of Variation is useful in determining

A

which investment has more relative risk when investments have different average returns

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5
Q

Coefficient of Variation tell us the probability

A

of actually experiencing a return close to the average return

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6
Q

The higher the coefficient of variation,

A

the more risky an investment per unit of return

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7
Q

Formula for Coefficient of Variation

A

Standard Deviation/

Average Return

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8
Q

Normal Distribution is appropriate if an investor is

A

considering a range of investment returns

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9
Q

A Lognormal Distribution is appropriate if an investor is considering

A

a DOLLAR AMOUNT or PORTFOLIO VALUE at a point in time

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10
Q

SKEWNESS refers to a normal distribution curve that is shifted

A

to the left of right of the MEAN RETURN

Ex: Commodity Returns

Left: Positive Skewness
Right: Negative Skewness

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11
Q

Kurtosis refers to

A

the variation of returns

Little variation= distribution has a high peak (Treasuries)

Widely dispersed = low peak, negative Kurtosis

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12
Q

Leptokurtic distributions mean what?

A

High peak, fat tails

Higher change of extreme events

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13
Q

Platykurtic distributions mean what?

A

Low peak, thin tails

Low chance of extreme events

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14
Q

Mean Variance Optimization means adding what kind of securities to your portfolio?

A

Process of adding RISKY securities BUT keeping the expected return the same.

Low variance as measured by standard deviation

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15
Q

What is a Monte Carlo Simulation?

A

Spreadsheet simulation that gives a probabilistic distribution of events occurring

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16
Q

Covariance is the measure of

A

2 securities combined and their interactive risk

How price movements between 2 securities are related to each other

Measure of RELATIVE RISK

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17
Q

Correlation and Covariance are both

A

Relative measures

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18
Q

Correlation Coefficent of 1

A

Denotes two assets are perfectly correlated

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19
Q

Correlation Coefficient of 0

A

Denotes that assets are completely uncorrelated

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20
Q

Correlation Coefficient of -1

A

Denotes perfectly negative correlation

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21
Q

When combining asset classes, an investor begins to receive diversification benefits when correlation is

A

Less than 1

22
Q

Beta Coefficient is a measure of

A

an individual security’s volatility relative to that of the market

Measure of systematic/market risk

23
Q

Beta is best used to measure

A

the volatility of a diversified portfolio

the Beta of the market is 1

24
Q

A stock with a beta HIGHER THAN 1

A

Means the stock fluctuates more than the market and greater risk is associated

25
Q

A stock with a beta LOWER THAN 1

A

Indicates that the security fluctuates less relative to market movements

26
Q

If a fund has a return of 20% and the market has a return of 10%, the beta would be:

A

2

Security risk premium / Market risk premium

27
Q

Coefficient of DETERMINATIONS (R-Squared) is a measure of

A

How much return is due to the market

OR

What percentage of a security’s return is due to the market

28
Q

Market (systematic) Risk

A

Return from the market

Lowest level of risk one could expect in a fully diversified portfolio

Non-diversifiable

Economy-based risk

29
Q

Unsystematic Risk

A

Risks that are not shared with a wider market or industry (specific to a company/investment)

30
Q

Portfolio risk can be measured through

A

determination of the interactivity of the standard deviation and the covariance of securities in the portfolio

31
Q

Systematic Risks: P-R-I-M-E

A

Purchasing Power Risk
Reinvestment Rate risk (bonds)
Interest Rate Risk
Market Risk
Exchange Rate Risk

32
Q

Unsystematic Risks: A-B-C-D-E-F-G

A

Accounting risk
Business risk
Country risk
Default risk
Executive risk
Financial risk
Government/regulation risk

33
Q

Modern Portfolio Theory

A

The acceptance by an investor of a given level of risk while maximizing return objectives

34
Q

Modern Portfolio Theory: EFFICIENT FRONTIER

A

The curve which illustrates the best possible returns that could be expected from all possible portfolios

35
Q

Modern Portfolio Theory: INDIFFERENCE CURVES

A

Constructed using selections made based on this highest level of return given an acceptable level of risk

36
Q

Modern Portfolio Theory: EFFICIENT PORTFOLIO

A

Occurs when an investor’s indifference curve is tangent to the efficient frontier

37
Q

Modern Portfolio Theory: OPTIMAL PORTFOLIO

A

the one selected from all efficient portfolios

the point at which an investor’s indifference curve is tangent to the efficient frontier, represents that investor’s optimal portfolio

38
Q

Capital Market Line (CML)

A

the macro aspect of the Capital Asset Pricing Model (CAPM)

a portfolio’s return should be on the CML

39
Q

What measure of risk does the Capital Market Line (CML) use?

A

Standard deviation

40
Q

Capital Asset Pricing Model (CAPM) calculates

A

the relationship of risk and return of an individual security using BETA as it’s measure of risk

“Security Market Line” SML

41
Q

SML uses what as its measure of risk?

A

Beta

42
Q

What is the intersection on the y-axis of CML/SML

A

The risk-free rate of return

43
Q

Information Ratio

A

Relative risk-adjusted performance measure

The higher, the better

44
Q

Treynor Index

A

NUMERATOR: the difference between the portfolio return and risk-free return

DENOMINATOR: Beta of a portfolio

RISK-ADJUSTED performance measure

45
Q

Sharpe Index

A

Provides a measure of portfolio performance using a risk-adjusted measure that standardizes returns for their variability

NUMERATOR: the difference between the portfolio return and risk-free return

DENOMINATOR: Standard deviation of a portfolio

RISK-ADJUSTED performance measure

Better for NON-diversified portfolios

46
Q

Jensen Model or Jensen’s Alpha measures

A

a manager’s performance relative to that of the market

Can determine differences between realized or actual returns and required returns as specified by CAPM

ABSOLUTE PERFORMANCE on a risk-adjusted basis

positive Alpha is good
negative is BAD

47
Q

A portfolio is considered diversified if its R-squared is greater than

A

0.70

Any less = not well diversified (use Sharpe Index as measure)

REMEMBER! If correlation is 0.80, r-squared is 64%

48
Q

If the exam doesn’t give you the R-squared, which performance measure should you use?

A

Sharpe Index

49
Q

Total Risk = Systematic = Unsystematic Risk

Total risk is measured using ______

Systematic risk is measured using ______

A

Total Risk = Systematic = Unsystematic Risk

Total risk is measured using STANDARD DEVIATION

Systematic risk is measured using BETA

50
Q

The Beta of the Market is ____

A

1.0

51
Q

A stock that has a Beta of 1.5 is riskier or less risky than the market?

A

Riskier

52
Q

R-squared tells us what about Beta?

A

R-Squared will give us insight as to whether or not Beta is an appropriate measure of risk

If R-Squared is greater than .7 then YES, it is a good measure to use to assess RISK

CFP Exam (23 decks)

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