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Investment Analysis & Portfolio
Management Final Exam 2025/2026 –
Fully Solved Questions with Risk, Return,
and Valuation Concepts
1. What is the primary goal of diversification in portfolio management?
a) Increase portfolio return
b) Reduce portfolio risk
c) Guarantee positive returns
d) Minimize transaction costs
Rationale: Diversification reduces portfolio risk by spreading investments across assets
with uncorrelated returns, minimizing the impact of any single asset’s performance.
2. A stock has an expected return of 10% and a standard deviation of 15%. If the risk-free
rate is 3%, what is the stock’s Sharpe ratio?
a) 0.47
b) 0.47
c) 0.67
d) 0.87
Rationale: Sharpe ratio = (Expected return – Risk-free rate) / Standard deviation = (10%
– 3%) / 15% = 0.47.
3. According to the Capital Asset Pricing Model (CAPM), what determines a stock’s
expected return?
a) Total risk
b) Systematic risk
c) Unsystematic risk
d) Dividend yield
Rationale: CAPM states that a stock’s expected return is determined by its systematic
risk (beta), as unsystematic risk is diversified away.
4. Problem Set: Calculate the expected return of a stock with a beta of 1.2, given a risk-free
rate of 4% and a market return of 12%.
Solution:
Expected return = Risk-free rate + Beta × (Market return – Risk-free rate)
= 4% + 1.2 × (12% – 4%) = 4% + 1.2 × 8% = 4% + 9.6% = 13.6%
Rationale: CAPM formula calculates expected return based on beta, risk-free rate, and
market risk premium.
5. Which of the following best describes systematic risk?
a) Risk specific to an individual stock
b) Risk that can be diversified away
c) Risk affecting the entire market
d) Risk due to poor management
, 2
Rationale: Systematic risk, or market risk, affects the entire market and cannot be
diversified away.
6. A portfolio consists of two assets: Asset A (60% weight, standard deviation 10%) and
Asset B (40% weight, standard deviation 15%). The correlation coefficient is 0.4. What is
the portfolio’s standard deviation?
Solution:
Portfolio variance = (w_A² × σ_A²) + (w_B² × σ_B²) + 2 × w_A × w_B × σ_A × σ_B × ρ
= (0.6² × 0.10²) + (0.4² × 0.15²) + 2 × 0.6 × 0.4 × 0.10 × 0.15 × 0.4
= (0.36 × 0.01) + (0.16 × 0.0225) + (0.048 × 0.4)
= 0.0036 + 0.0036 + 0.00192 = 0.00912
Portfolio standard deviation = √0.00912 = 0.0955 or 9.55%
Rationale: Portfolio standard deviation accounts for individual asset risks, weights, and
correlation to measure total risk.
7. What does a beta of 0 indicate about a stock?
a) High volatility
b) No systematic risk
c) Negative correlation with the market
d) Guaranteed returns
Rationale: A beta of 0 indicates the stock’s returns are uncorrelated with the market,
implying no systematic risk.
8. Problem Set: A portfolio has an expected return of 15% and a standard deviation of
20%. The risk-free rate is 5%. What is the Treynor ratio if the portfolio’s beta is 1.5?
Solution:
Treynor ratio = (Portfolio return – Risk-free rate) / Beta
= (15% – 5%) / 1.5 = 10% / 1.5 = 0.0667 or 6.67%
Rationale: Treynor ratio measures excess return per unit of systematic risk (beta).
9. Which of the following reduces unsystematic risk?
a) Investing in a single stock
b) Holding a diversified portfolio
c) Increasing leverage
d) Investing in high-beta stocks
Rationale: Unsystematic risk, specific to individual assets, is reduced through
diversification by holding multiple uncorrelated assets.
10. A stock’s expected return is 8%, and its beta is 0.8. If the risk-free rate is 3% and the
market return is 10%, is the stock overvalued or undervalued according to CAPM?
Solution:
CAPM expected return = 3% + 0.8 × (10% – 3%) = 3% + 0.8 × 7% = 3% + 5.6% = 8.6%
Actual return = 8% < CAPM expected return (8.6%)
Undervalued
Rationale: If the actual return is less than the CAPM expected return, the stock is undervalued,
as it offers less return than required for its risk.
11. What is the main assumption of the Efficient Market Hypothesis (EMH)?
a) Investors are always irrational
Investment Analysis & Portfolio
Management Final Exam 2025/2026 –
Fully Solved Questions with Risk, Return,
and Valuation Concepts
1. What is the primary goal of diversification in portfolio management?
a) Increase portfolio return
b) Reduce portfolio risk
c) Guarantee positive returns
d) Minimize transaction costs
Rationale: Diversification reduces portfolio risk by spreading investments across assets
with uncorrelated returns, minimizing the impact of any single asset’s performance.
2. A stock has an expected return of 10% and a standard deviation of 15%. If the risk-free
rate is 3%, what is the stock’s Sharpe ratio?
a) 0.47
b) 0.47
c) 0.67
d) 0.87
Rationale: Sharpe ratio = (Expected return – Risk-free rate) / Standard deviation = (10%
– 3%) / 15% = 0.47.
3. According to the Capital Asset Pricing Model (CAPM), what determines a stock’s
expected return?
a) Total risk
b) Systematic risk
c) Unsystematic risk
d) Dividend yield
Rationale: CAPM states that a stock’s expected return is determined by its systematic
risk (beta), as unsystematic risk is diversified away.
4. Problem Set: Calculate the expected return of a stock with a beta of 1.2, given a risk-free
rate of 4% and a market return of 12%.
Solution:
Expected return = Risk-free rate + Beta × (Market return – Risk-free rate)
= 4% + 1.2 × (12% – 4%) = 4% + 1.2 × 8% = 4% + 9.6% = 13.6%
Rationale: CAPM formula calculates expected return based on beta, risk-free rate, and
market risk premium.
5. Which of the following best describes systematic risk?
a) Risk specific to an individual stock
b) Risk that can be diversified away
c) Risk affecting the entire market
d) Risk due to poor management
, 2
Rationale: Systematic risk, or market risk, affects the entire market and cannot be
diversified away.
6. A portfolio consists of two assets: Asset A (60% weight, standard deviation 10%) and
Asset B (40% weight, standard deviation 15%). The correlation coefficient is 0.4. What is
the portfolio’s standard deviation?
Solution:
Portfolio variance = (w_A² × σ_A²) + (w_B² × σ_B²) + 2 × w_A × w_B × σ_A × σ_B × ρ
= (0.6² × 0.10²) + (0.4² × 0.15²) + 2 × 0.6 × 0.4 × 0.10 × 0.15 × 0.4
= (0.36 × 0.01) + (0.16 × 0.0225) + (0.048 × 0.4)
= 0.0036 + 0.0036 + 0.00192 = 0.00912
Portfolio standard deviation = √0.00912 = 0.0955 or 9.55%
Rationale: Portfolio standard deviation accounts for individual asset risks, weights, and
correlation to measure total risk.
7. What does a beta of 0 indicate about a stock?
a) High volatility
b) No systematic risk
c) Negative correlation with the market
d) Guaranteed returns
Rationale: A beta of 0 indicates the stock’s returns are uncorrelated with the market,
implying no systematic risk.
8. Problem Set: A portfolio has an expected return of 15% and a standard deviation of
20%. The risk-free rate is 5%. What is the Treynor ratio if the portfolio’s beta is 1.5?
Solution:
Treynor ratio = (Portfolio return – Risk-free rate) / Beta
= (15% – 5%) / 1.5 = 10% / 1.5 = 0.0667 or 6.67%
Rationale: Treynor ratio measures excess return per unit of systematic risk (beta).
9. Which of the following reduces unsystematic risk?
a) Investing in a single stock
b) Holding a diversified portfolio
c) Increasing leverage
d) Investing in high-beta stocks
Rationale: Unsystematic risk, specific to individual assets, is reduced through
diversification by holding multiple uncorrelated assets.
10. A stock’s expected return is 8%, and its beta is 0.8. If the risk-free rate is 3% and the
market return is 10%, is the stock overvalued or undervalued according to CAPM?
Solution:
CAPM expected return = 3% + 0.8 × (10% – 3%) = 3% + 0.8 × 7% = 3% + 5.6% = 8.6%
Actual return = 8% < CAPM expected return (8.6%)
Undervalued
Rationale: If the actual return is less than the CAPM expected return, the stock is undervalued,
as it offers less return than required for its risk.
11. What is the main assumption of the Efficient Market Hypothesis (EMH)?
a) Investors are always irrational
