Investment Theory and Portfolio Management Quiz

An investor who prefers taking on more risk, even if it means potentially losing more money.

An investor who wants to minimize risk. They only accept higher risk if the potential reward is significantly greater.

An investor who is indifferent to risk and only focuses on expected return. They don't care if the investment is risky or stable as long as the projected return is the same.

A document that outlines an investor's investment goals, risk tolerance, and any constraints on their portfolio.

The process of selecting and managing assets with the aim of achieving an optimal balance between risk and return.

A set of investment guidelines specified in the IPS that reflects an investor's willingness to take on risk.

A challenge faced by investors in choosing the best combination of assets to maximize returns while minimizing risk.

The process of determining the proportion of assets to be allocated to different asset classes (e.g., stocks, bonds, real estate).

The uncertainty of an investment's future outcomes. Measured by the variance or deviation from expected returns.

The reward an investor receives for investing their capital. Calculated as the return on investment over a specific period.

A collection of assets like stocks, bonds, property, or currencies held by an investor.

The set of all possible portfolios an investor can choose based on their combination of risk and return.

The process of mixing different assets in a portfolio to reduce unsystematic risk. It spreads risk by balancing the negative performance of one asset with the positive performance of others.

A model that aims to find the 'optimal' portfolio by considering the trade-off between an investment's expected return and risk. It quantifies diversification and forms the foundation for asset allocation.

Investors consider each investment's potential outcomes as a probability distribution of expected returns within a specific time period.

Investors prioritize maximizing their utility, which is their satisfaction from wealth, over a single period. Their utility curves exhibit decreasing marginal utility of wealth, meaning additional wealth brings less satisfaction as their wealth increases.

Measures how returns of two different investments move together over time. A positive covariance means they move in the same direction, while a negative covariance signifies opposite movements.

A statistical measure of how strongly two variables change in relation to each other. It shows how much one variable changes when the other changes.

A type of correlation where variables move in the same direction. If one goes higher, the other also goes higher.

When variables move in opposite directions. If one increases, the other decreases.

The direction of the relationship between two variables and how much they change together. Positive when both increase/decrease, negative when moving oppositely.

A portfolio is considered 'efficient' when no other portfolio offers a higher expected return for the same or lower risk, or lower risk for the same or higher expected return.

Measures how much a variable deviates from its average value. Used to quantify risk by showing how much returns vary from their expected value.

A measure of risk that only considers deviations below the expected return. It focuses on how much the portfolio might underperform.

The tendency of two assets or variables to move together. Positive covariance means they move in the same direction, negative means opposite directions.

The expected return of a portfolio is simply the weighted average of the expected returns of the individual assets in the portfolio. The weights are the proportions of each asset in the portfolio.

The expected return of an individual asset is calculated as the sum of the potential returns multiplied by their respective probabilities.

The risk of an individual asset is measured by its variance, which is the average squared deviations from the expected return. It captures how much the actual return might deviate from its expected value.

The expected rate of return of a portfolio is a weighted average of the individual assets' expected rates of return, where the weights represent the proportions of the portfolio invested in each asset.

Diversification that involves investing equal amounts across a wide range of assets without considering their individual characteristics or correlations.

The process of constructing investment portfolios that optimize the balance between risk and return based on the correlations and variances of the assets within the portfolio.

The theoretical benefit of diversification is that as the number of assets in a portfolio increases, the overall portfolio risk (specific risk) can be reduced significantly.

The potential difficulty in accurately predicting future returns and correlations of assets, which can make constructing an optimal portfolio challenging.

The standard deviation of a portfolio reflects the overall risk of the investment. It measures how much the portfolio's returns are expected to deviate from their average, indicating the level of volatility.

The correlation coefficient is a statistical measure that describes the relationship between the returns of two assets. It ranges from -1 to +1. Positive correlation means assets move in the same direction, while negative correlation means they move in opposite directions.

The expected rate of return is the average return an investor anticipates receiving from an asset over a particular time period. This is a prediction, not a guarantee, based on historical data and future expectations.

Standard deviation of returns measures the volatility or risk of an individual asset. It shows how much the asset's returns are expected to deviate from their average.

Negative correlation between assets is a desirable characteristic in portfolio management. It means that when one asset's return falls, the other's return tends to rise. This helps reduce overall portfolio risk.

The efficient frontier is a graphic representation of the optimal portfolio combinations. It shows the highest expected return for each level of risk or the lowest risk for each level of return.

Investor utility represents an individual's preferences toward risk and return. It's their personal trade-off between these two factors. Different investors have different utility curves, reflecting their unique risk tolerance.

The optimal portfolio for a given investor is the one that lies at the tangent point between the efficient frontier and the investor's utility curve. This portfolio offers the highest utility for that particular investor.