Chapter 4 - Investment Planning

Question 1

Degree by which two assets are RELATED to each other?

Answer 1

Correlation Coefficient (R)

Question 2

+1 indicates:
0 indicates:
-1 indicates:

Answer 2

+1 indicates: Perfect Correlation
0 indicates: No Correlation
-1 indicates: Negative Correlation

Question 3

Formula for standard deviation:

Answer 3

Sq Root of Variance

Question 4

How do you calculate variance?

Answer 4

(Sum of squared differences between actual and expected return) / (Total # of observations - 1)

Question 5

When do the greatest diversification benefits occur?

Answer 5

When portfolio is perfect -1 opposite correlation

Question 6

Represents all possible portfolios that can be constructed?

Answer 6

Efficient Frontier

Question 7

Indifference curve placement here indicates higher utility

Answer 7

Up and to the left

Question 8

Modern Portfolio Theory combines the efficient frontier with 2 components?

Answer 8

RFR and Beta

Question 9

What is beta?

Answer 9

Measure of a portfolios risk

Question 10

What is the risk free rate?

Answer 10

Current Return on Treasury Bills

Question 11

Measures the risk/return relationship for efficient portfolios of securities?

Answer 11

Securities Market Line

Question 12

What are the 3 assumptions under CAPM?

Answer 12

1) Investors are Rational
2) Investors can borrow and lend at the RFR
3) Assume Taxes & Fees @ 0%

Question 13

To the left of Point of Tangency on the efficient frontier of the Capital Market Line?

Answer 13

Lending Portfolios

Question 14

All investments into a market portfolio?

Answer 14

Point of Tangency

Question 15

To the right of the point of tangency on the capital market line?

Answer 15

Borrowing Portfolios

Question 16

What is the CML Capital Money Line Formula?

Answer 16

(RFR + Standard Deviation of Portfolio) X (Market Return - RFR) / Standard Deviation of Market

Question 17

What is the Sharpe Ratio formula?

Answer 17

(Market Return - RFR) / Standard Deviation of Market

Question 18

Relative measure of portfolio performance in which total risk is measured by standard deviation is used to estimate risk adjusted performance.

Answer 18

Sharpe Ratio

Question 19

This ratio is only meaningful when compared to alternative investments.

Answer 19

Sharpe Ratio

Question 20

Sharpe Ratio measures what?

Answer 20

Risk adjusted performance (based on standard deviation)

Question 21

What is the formula for risk premium?

Answer 21

(Market Return - RFR)

Question 22

As risk premium decreases CML slope __________ .

Answer 22

Decreases

Question 23

Measure of how much 2 assets MOVE together?

Answer 23

Covariance

Question 24

Securities market line OR CAPM Formula:

Answer 24

RFR + Beta (Market Return - RFR)

Question 25

How is variance calculated?

Answer 25

Standard Deviation Squared

Question 26

What does CAPM calculate?

Answer 26

Required Return

Question 27

Asset pricing model describes relationship between risk and return takes into account changes in inflation and GDP

Answer 27

APT - Arbitrage Pricing Theory

Question 28

This theory states that perfect substitutes must sell for the same price.

Answer 28

Law of One Price

Question 29

Measures the ability of an investor to stay invested when prices rise.

Answer 29

Risk Tolerance

Question 30

8 Major Factors to Consider when determining investors risk tolerance.

Answer 30

- Loss Aversion - Available Liquidity - Savings - Psychographics - Insurance - Time Horizon - Goals - Phase of Life cycle

Question 31

When an investor has experienced too many losses and "calls it quits."

Answer 31

Loss Aversion

Question 32

Least risk for highest return

Answer 32

Efficient Portfolio

Question 33

Another word for "willingness"

Answer 33

Propensity

Question 34

What is the ideal allocations for a client age 65-death?

Answer 34

- Relatively liquid investments, enough to fund 5 years of expenditures - Rest of portfolio - moderate growth

Question 35

3 common approaches to asset allocation?

Answer 35

1) Strategic 2) Tactical 3) Mean Variance Optimization

Question 36

Risk /Return Trade-off considering investor goals

Answer 36

Strategic

Question 37

Approach to asset allocation that seeks to outperform market?

Answer 37

Tactical

Question 38

Allocation style that seeks to maximize return for selected level of risk?

Answer 38

Mean variance

Question 39

Strategy that uses index funds to fulfill the core components of the desired asset allocation?

Answer 39

Core Satellite

Question 40

Trying to predict where an economic cycle is heading in the future and timing it.

Answer 40

Sector Rotation

Question 41

Occurs when a mutual fund begins to diverge from its stated objective.

Answer 41

Style Drift