Portfolio Management

Question 1

What is the portfolio approach to investments?

Answer 1

The portfolio approach involves evaluating all assets in an investment portfolio collectively, focusing on the overall expected return and risk.

Question 2

How does the portfolio approach help reduce risk?

Answer 2

The portfolio approach helps reduce risk through diversification, selecting a variety of assets to include in the portfolio.

Question 3

What is an example of the benefits of portfolio diversification?

Answer 3

Investing all savings in a single company’s shares can lead to total loss if the company goes bankrupt, whereas investing only a portion reduces the impact of such a loss.

Question 4

Why is diversification important in the portfolio approach?

Answer 4

Diversification protects investors from significant losses that can occur with a non-diversified portfolio.

Question 5

How Investments in individual securities and portfolios are primarily characterized?

Answer 5

Characterized by: Expected return and risk.

Question 6

How is risk defined from a neutral perspective in finance?

Answer 6

Risk is seen as the unknown outcome of a project, focusing on volatility and measured by standard deviation and variance.

Question 7

What is the expected return on a portfolio?

Answer 7

It is the weighted average of the expected returns on individual assets in the portfolio.

Question 8

How is portfolio risk measured and why is it usually lower than individual asset risks?

Answer 8

Portfolio risk is measured by standard deviation and is usually lower due to the correlation between assets.

Question 9

What is the diversification ratio and what does a ratio of 80% indicate?

Answer 9

The diversification ratio is the standard deviation of an equally weighted portfolio divided by the standard deviation of a randomly selected asset. A ratio of 80% indicates the portfolio’s risk is 20% lower than that of a randomly selected security.

Question 10

How does diversification reduce investment risk?

Answer 10

By spreading investments across different assets, the overall risk is reduced, as the impact of any single asset’s poor performance is minimized.

Question 11

Why is the correlation between assets important for diversification?

Answer 11

The lower the correlation between assets, the stronger the effect of diversification, which helps mitigate risk.

Question 12

What happens to asset correlations during market downturns?

Answer 12

During market downturns, correlations between assets tend to increase, reducing the benefits of diversification.

Question 13

How does a weak and declining market affect diversification?

Answer 13

In weak and declining markets, the effect of diversification is diminished, and the possibility of loss becomes more dependent on the overall economic situation.

Question 14

Do asset correlations remain constant over time?

Answer 14

No, the correlation between assets changes over time.

Question 15

What does the risk-return trade-off represent?

Answer 15

The risk-return trade-off represents the relationship between expected return and risk for both individual assets and portfolios.

Question 16

How can portfolios benefit from the risk-return trade-off?

Answer 16

By combining assets in the right proportions, investors can create portfolios with the same expected return but lower risk compared to individual assets.

Question 17

Why is the selection of asset proportions important in portfolio management?

Answer 17

Proper selection of asset proportions helps achieve the desired expected return while minimizing risk, demonstrating the benefits of the portfolio approach.

Question 18

Who formally defined Modern Portfolio Theory (MPT)?

Answer 18

Harry Markowitz formally defined MPT in 1952 with his article “Portfolio Selection.”

Question 19

What is the main focus of Modern Portfolio Theory?

Answer 19

The main focus is on choosing the best investments based on the expected rate of return and risk, emphasizing the importance of asset correlation.

Question 20

How should rational investors minimize risk according to MPT?

Answer 20

Rational investors should minimize risk through portfolio diversification.

Question 21

What well-known model is based on Modern Portfolio Theory?

Answer 21

The Capital Asset Pricing Model (CAPM) is based on Modern Portfolio Theory.

Question 22

Who are the main market participants in financial markets?

Answer 22

Cash surplus entities (investors), deficit entities (seeking funding), and financial intermediaries (institutions facilitating contact).

Question 23

How are investors categorized?

Answer 23

Investors are categorized into individual investors and institutional investors.

Question 24

What are some examples of institutional investors?

Answer 24

Examples include pension plans, endowments, banks, insurance companies, and investment companies.

Question 25

What is the role of financial markets?

Answer 25

Financial markets are places where transactions in financial instruments occur, allowing participants to exchange capital.

Question 26

What does portfolio management involve?

Answer 26

Portfolio management involves selecting and managing a mix of investment assets to meet the needs and limitations of market participants.

Question 27

What are some examples of individual investors' objectives?

Answer 27

Purchasing a new car, funding children's education, and securing retirement through a pension plan.

Question 28

Why do investment portfolios need to be tailored for individual investors?

Answer 28

Because different investment objectives require specific structures that meet a person's current needs and financial goals.

Question 29

What is a defined contribution pension plan?

Answer 29

It is a pension plan where individuals have control over their portfolios and emphasize diversification to achieve their investment goals.

Question 30

What categories can be used to define individual investors?

Answer 30

Risk tolerance, time horizon for investments, income needs, and liquidity needs.

Question 31

Why is it difficult to generalize the needs of individual investors?

Answer 31

Because each individual's investment objectives and financial circumstances are unique.

Question 32

What is the first step in the portfolio management process?

Answer 32

The planning step, which involves defining investment objectives, risk tolerance, constraints, and developing an investment policy statement.

Question 33

What occurs during the execution step of portfolio management?

Answer 33

The execution step involves making actual investment decisions, selecting assets, allocating resources, and making trades to build the portfolio.

Question 34

What is the purpose of the feedback step in portfolio management?

Answer 34

The feedback step involves monitoring the portfolio's performance, comparing results to objectives, and making necessary adjustments to stay aligned with the investor's goals.

Question 35

What is the purpose of the planning step in the portfolio management process?

Answer 35

To thoroughly plan each fund for effective management and accountability of the fund manager

Question 36

What should a manager understand about their client during the planning step?

Answer 36

The manager should understand the client's investment objectives, financial situation, and risk profile.

Question 37

What is an Investment Policy Statement (IPS)?

Answer 37

An IPS is an agreement between the client and the manager that documents the investment plan and characteristics, serving as a reference for managing the portfolio.

Question 38

Why is it important to document investment characteristics in the planning step?

Answer 38

Documenting investment characteristics forms the basis of the agreement and ensures clarity and alignment between the client's expectations and the manager's actions.

Question 39

What are the three substeps in the execution step of portfolio management?

Answer 39

Asset allocation, analysis of particular securities or individual assets, and creating the portfolio.

Question 40

What is asset allocation and why is it important?

Answer 40

Asset allocation determines the overall portfolio construction based on major asset classes and reflects the risk and expected return. It’s important for achieving the desired rates of return and managing risk.

Question 41

What does the analysis of particular securities or individual assets involve?

Answer 41

It involves researching market sectors and selecting companies or commodities that are expected to provide the desired rate of return as per the investment policy.

Question 42

What is the focus when creating the portfolio?

Answer 42

The focus is on selecting assets that ensure the best possible diversification and minimize risk while meeting the client's expected rate of return.

Question 43

What are the two substeps in the feedback step of portfolio management?

Answer 43

Monitoring the portfolio and assessing the performance of portfolio management.

Question 44

Why is it important to monitor the portfolio?

Answer 44

To introduce appropriate alterations in response to changing economic conditions and to adjust the portfolio to the client's requirements.

Question 45

How is the performance of portfolio management assessed?

Answer 45

By periodically evaluating the portfolio's performance over a certain period, usually in comparison with a benchmark, and summarizing the performance for the investor.

Question 46

How can a manager's compensation be linked to portfolio management?

Answer 46

The manager's compensation is often based on how effectively they manage the portfolio.

Question 47

Why should portfolio performance be summarized and presented to the investor?

Answer 47

To keep the investor informed about how their portfolio is performing and to ensure transparency in the management process.