Principles of Investment - Risk & Return

Question 1

Define Risk Premium

Answer 1

Additional return that is required by investors for taking on the risk of the investments

Question 2

Define Systematic Risk

Answer 2

The risk that an entire financial system of market may collapse

Question 3

Define Financial Gearing

Answer 3

Describes the relationship between the amount of debt taken out by a firm to finance activities

Question 4

Define Unsystematic Risk

Answer 4

Known as a specific/unique risk and relate to a particular business investment or share

Question 5

Define counterparty risk

Answer 5

risk that a counterparty in a transaction cannot honour its financial obligations

Question 6

Define Market Capitalisation

Answer 6

Larger companies can be more insulated from economic downturns than smaller ones

Question 7

What is ESG investing

Answer 7

ESG refers to Environmental, Social and Governance & addressing one of these dimensions for sustainable investing

Question 8

Define Corporate Governance

Answer 8

Refers to the way in which businesses are directed and controlled

Question 9

How is standard deviation used

Answer 9

It measures how widely the investment is dispersed around its mean or average
Higher the SD the greater the risk

Question 10

How is the money rated return formula used

Answer 10

Measure the performance of an investment that has had deposits and withdrawals during the period of investment

Question 11

How is time-weighted rate of return used

Answer 11

Refers to the fact returns are averaged over time and removes impact of cash flow

Question 12

How does the sharpe ratio work

Answer 12

compares rate of return with its risk

Question 13

How is Jensen Alpha used

Answer 13

It is employed to evaluate the performance of a well-diversified portfolio against a CAPM benchmark

Question 14

What is CAPM

Answer 14

financial model that calculates the expected rate of return for an asset or investment

Question 15

What is the Efficient Market Hypothesis

Answer 15

It is a theory that puts forward all available and relevant info about a security and is reflected in the security’s value

Question 16

What are the underpinnings of the Modern Portfolio Theory

Answer 16

• Investors will demand higher returns for investors to invest in riskier assets
• Diversifying a portfolio by adding investments which do not behave in the same way to reduce risk

Question 17

What does the efficient frontier represent?

Answer 17

Curve shows the different rates of return against the amount of risk

Question 18

What is Fama-French Three Factor model

Answer 18

aims to describe stock returns through - company size, book-to-market values, excess returns on market

Question 19

What is the use of Beta

Answer 19

expression of a funds sensitivity to movements in the benchmark index

Question 20

What is the use of Alpha

Answer 20

measures the difference between funds actual returns and expected returns

Question 21

What is Top down strategy and what are its stages

Answer 21

Involves the manager considering the bigger picture and asset allocation, sector selection and stock selection

Question 22

What is bottom-up management

Answer 22

focuses solely on unique attractions of individual stocks

Question 23

What is a Passive strategy

Answer 23

A method which seeks to maximise returns by minimising buying and selling

Question 24

Name some Passive strategies

Answer 24

Buy & Hold and Indexation (replicating the performance of market index)