Modern portfolio theory

1 What is 'standard deviation' in the context of investments?

A) The measure of investment risk based on average return deviation

2 What is the impact of perfect positive correlation between two investments in a portfolio according to Modern Portfolio Theory?

E) Returns move identically, thus not providing any diversification benefits.

3 The standard deviation of a portfolio is calculated by adding up the standard deviations of the individual investments weighted by their portfolio proportions

B) False

4 What does the 'Sharpe Ratio' measure?

C) The return per unit of risk

5 How does the introduction of international investments affect a portfolio's risk and return?

A) It can offer diversification benefits by eliminating country specific risks.

6 Which risk remains even after you diversify?

D) Systematic risk

7 Why might two investments with high individual risks provide a lower risk when combined in a portfolio?

E) If the investments are negatively correlated, they can offset each other's risk.

8 What do we mean by the 'weight of a portfolio'?

A) The proportion of each investment within the portfolio

9 Systematic and unsystematic risks differ in that:

E) Unsystematic risk can be reduced through diversification, while systematic risk cannot

10 Which term describes the uncertainty associated with an investment's return?

A) Risk

11 In the context of portfolios, what does the correlation coefficient measure?

E) The similarity in return movements between two investments

12 What is the primary goal of Modern Portfolio Theory (MPT)?

E) To maximize return per unit of risk

13 What does 'naïve diversification' refer to?

A) Purchasing multiple investments

14 You can only eliminate unsystematic risk if the correlation of two investments is less than 0.

B) False

15 How does 'efficient diversification' differ from 'naïve diversification'?

B) It seeks to minimize risk without sacrificing return

16 Which of the following best describes 'systematic risk'?

D) Risk that affects all investments in the market

17 What is meant by 'optimal diversification' in Modern Portfolio Theory?

B) Minimizing risk while simultaneously maximizing return

18 Which of the following best describes the impact of adding more stocks to a diversified portfolio?

D) Unsystematic risk decreases, potentially down to negligible levels.

19 What is the primary benefit of combining investments with low correlation in a portfolio?

D) It reduces overall portfolio risk by eliminating unsystematic risk.

20 In modern portfolio theory, what is the difference between naïve diversification and optimal diversification?

D) Naïve diversification includes investments regardless of their correlations, potentially increasing portfolio risk, while optimal diversification selects investments with low or negative correlations to minimize risk.

21 What does a 'portfolio's expected return' represent?

C) The average value of all possible future outcomes

22 All diversification has the same impact on your portfolio’s risk and return.

B) False

23 What does 'unsystematic risk' refer to?

C) Risk specific to an individual investment

24 What does perfect negative correlation between two investments in a portfolio imply?

A) Returns on one investment move exactly opposite to the returns on the other, achieving the maximum benefits of diversification.

25 How is the 'expected return of a portfolio' calculated?

E) By adding up the expected returns of the investments weighted by their portfolio proportions

26 What is 'expected return' in the context of investments?

C) The average of all possible investment outcomes

27 What is the key objective when constructing a portfolio according to Modern Portfolio Theory?

D) To maximize returns while minimizing risk

28 Which of the following best explains 'portfolio'?

C) A collection of diverse investments

29 What is the impact of systematic risk on an optimally diversified portfolio?

B) It remains and cannot be diversified away.

30 What does the 'standard deviation of a portfolio' measure?

C) The average deviation of the portfolio returns from the expected return

31 What is meant by the 'rate of return' of an investment?

A) The profitability of the investment relative to its cost

32 What role does diversification play when investing?

E) To reduce overall investment risk

33 In the context of diversification, what is the significance of the correlation coefficient between investments in a portfolio?

E) A lower coefficient suggests better diversification benefits.