Risk and Return MCQs
What does “return” refer to in finance?
A) The risk associated with an investment
B) The profit or loss made from an investment
C) The amount invested in a security
D) The initial cost of an investment
Answer: B) The profit or loss made from an investment
What is “risk” in the context of investing?
A) The probability of receiving a fixed return
B) The chance of losing money or not achieving the expected return
C) The certainty of the investment’s outcome
D) The total amount of capital invested
Answer: B) The chance of losing money or not achieving the expected return
Which of the following is a measure of risk?
A) Beta
B) Earnings per share (EPS)
C) Dividend yield
D) Price-to-earnings ratio (P/E ratio)
Answer: A) Beta
What does “diversification” aim to achieve in an investment portfolio?
A) Higher returns with no risk
B) A decrease in overall risk by spreading investments across different assets
C) Maximizing the returns of a single investment
D) Ensuring investments are equally weighted
Answer: B) A decrease in overall risk by spreading investments across different assets
What is the “expected return” of an investment?
A) The return guaranteed by the investment
B) The average return that an investor anticipates to earn based on historical data
C) The minimum return required by an investor
D) The return that was actually earned in the past
Answer: B) The average return that an investor anticipates to earn based on historical data
Which measure of risk represents the variability of returns of a single asset?
A) Standard deviation
B) Correlation coefficient
C) Beta
D) Sharpe ratio
Answer: A) Standard deviation
What does “beta” measure in finance?
A) The total risk of an investment
B) The sensitivity of an asset’s returns to the returns of the market
C) The fixed return on an investment
D) The risk-free rate of return
Answer: B) The sensitivity of an asset’s returns to the returns of the market
What is the “Sharpe ratio” used for?
A) Measuring the return of an investment
B) Assessing the risk-adjusted return of an investment
C) Determining the total risk of an investment
D) Comparing different asset classes
Answer: B) Assessing the risk-adjusted return of an investment
What is meant by “systematic risk”?
A) Risk specific to a particular company or industry
B) Risk that affects the entire market or economy
C) Risk that can be eliminated through diversification
D) Risk that is not measurable
Answer: B) Risk that affects the entire market or economy
Which of the following is an example of a risk-free asset?
A) Corporate bonds
B) Treasury bills
C) Stocks
D) Real estate
Answer: B) Treasury bills
What does “market risk” refer to?
A) The risk of a company’s stock declining in value
B) The risk associated with fluctuations in market indices
C) The risk of interest rate changes affecting investments
D) The risk of an investment’s return being lower than the risk-free rate
Answer: B) The risk associated with fluctuations in market indices
What is “unsystematic risk”?
A) Risk that is due to market fluctuations
B) Risk that is specific to a particular company or industry
C) Risk that affects all investments equally
D) Risk that cannot be diversified away
Answer: B) Risk that is specific to a particular company or industry
Which of the following is used to calculate the expected return of a portfolio?
A) Weighted average of the expected returns of the individual assets
B) Sum of the actual returns of the individual assets
C) Average of the past returns of the portfolio
D) Standard deviation of the portfolio
Answer: A) Weighted average of the expected returns of the individual assets
What is the “capital asset pricing model” (CAPM) used to determine?
A) The historical returns of an asset
B) The risk-free rate of return
C) The expected return of an asset based on its risk
D) The correlation between different assets
Answer: C) The expected return of an asset based on its risk
What is “alpha” in the context of investing?
A) A measure of an investment’s total risk
B) The excess return of an investment relative to its expected return based on its beta
C) The risk-free rate of return
D) The average market return
Answer: B) The excess return of an investment relative to its expected return based on its beta
What is the primary purpose of the “efficient frontier” in modern portfolio theory?
A) To maximize the risk of a portfolio
B) To show the optimal risk-return trade-off for a portfolio
C) To minimize the number of assets in a portfolio
D) To identify the least risky assets
Answer: B) To show the optimal risk-return trade-off for a portfolio
What does the “risk-return trade-off” refer to?
A) The relationship between the risk of an investment and its potential return
B) The relationship between different types of risk
C) The relationship between the investment horizon and returns
D) The relationship between liquidity and risk
Answer: A) The relationship between the risk of an investment and its potential return
Which ratio measures the risk-adjusted return of a portfolio relative to its volatility?
A) Sharpe ratio
B) Beta
C) Alpha
D) Standard deviation
Answer: A) Sharpe ratio
What does “volatility” measure in finance?
A) The average return of an investment
B) The stability of an investment’s returns over time
C) The potential for an investment to increase in value
D) The total return of an investment
Answer: B) The stability of an investment’s returns over time
What is the “risk-free rate”?
A) The return on an investment with no risk
B) The return on an investment adjusted for inflation
C) The return on a government security with negligible risk
D) The average return on all market investments
Answer: C) The return on a government security with negligible risk
Which of the following would increase the risk of an investment?
A) Diversifying the portfolio
B) Investing in low-volatility assets
C) Investing in high-volatility assets
D) Investing in Treasury securities
Answer: C) Investing in high-volatility assets
What does “systematic risk” include?
A) Interest rate risk
B) Business risk
C) Default risk
D) Liquidity risk
Answer: A) Interest rate risk
Which of the following is a method used to measure the overall risk of a portfolio?
A) Beta
B) Alpha
C) Standard deviation
D) Dividend yield
Answer: C) Standard deviation
What is the “Jensen’s Alpha”?
A) A measure of the market’s volatility
B) The risk-free rate of return
C) The excess return of a portfolio compared to its expected return based on CAPM
D) The average market return
Answer: C) The excess return of a portfolio compared to its expected return based on CAPM
Which investment characteristic typically results in higher potential returns?
A) Low risk
B) High liquidity
C) High volatility
D) Fixed income
Answer: C) High volatility
What does “liquidity risk” refer to?
A) The risk of not being able to sell an investment quickly at its market price
B) The risk of default by the issuer
C) The risk of changes in interest rates
D) The risk of inflation affecting investment returns
Answer: A) The risk of not being able to sell an investment quickly at its market price
Which investment would typically have the highest risk?
A) Government bonds
B) Treasury bills
C) Blue-chip stocks
D) Start-up company stocks
Answer: D) Start-up company stocks
What is the “Treynor ratio” used for?
A) Measuring the return of an investment
B) Evaluating the risk-adjusted return of an investment based on systematic risk
C) Assessing the liquidity of an investment
D) Comparing the returns of different mutual funds
Answer: B) Evaluating the risk-adjusted return of an investment based on systematic risk
What does “duration” measure in bond investing?
A) The time until a bond matures
B) The risk of a bond’s return
C) The sensitivity of a bond’s price to changes in interest rates
D) The total return of a bond
Answer: C) The sensitivity of a bond’s price to changes in interest rates
What is “risk tolerance”?
A) The maximum amount of risk an investor is willing to take
B) The minimum return an investor expects
C) The total amount invested in risky assets
D) The risk-free rate of return
Answer: A) The maximum amount of risk an investor is willing to take
What is the “modigliani-miller theorem” related to?
A) The relationship between risk and return
B) The impact of capital structure on a firm’s value
C) The calculation of portfolio variance
D) The determination of the risk-free rate
Answer: B) The impact of capital structure on a firm’s value
Which of the following risk measures is based on past performance and variability of returns?
A) Beta
B) Value at Risk (VaR)
C) Standard deviation
D) Treynor ratio
Answer: C) Standard deviation
What is “Value at Risk” (VaR)?
A) The maximum potential loss an investment may face over a specified period
B) The minimum return expected from an investment
C) The risk-free return on an investment
D) The average return of a portfolio
Answer: A) The maximum potential loss an investment may face over a specified period
What does “capital allocation” refer to in portfolio management?
A) The process of selecting specific investments
B) The distribution of capital among different asset classes
C) The calculation of risk-adjusted returns
D) The assessment of market trends
Answer: B) The distribution of capital among different asset classes
What is the “security market line” (SML)?
A) A graphical representation of the expected return versus risk for different investments
B) A line showing the historical performance of securities
C) A measure of portfolio diversification
D) A tool for calculating the risk-free rate of return
Answer: A) A graphical representation of the expected return versus risk for different investments
What is “tracking error”?
A) The deviation of a portfolio’s returns from its benchmark index
B) The error in forecasting market returns
C) The mistake in calculating an investment’s beta
D) The discrepancy in historical performance data
Answer: A) The deviation of a portfolio’s returns from its benchmark index
What is the purpose of “hedging” in finance?
A) To eliminate all investment risk
B) To reduce or manage the risk of adverse price movements in an investment
C) To increase the potential returns of an investment
D) To diversify a portfolio
Answer: B) To reduce or manage the risk of adverse price movements in an investment
Which investment strategy aims to minimize risk while achieving a specific return target?
A) Active management
B) Passive management
C) Risk arbitrage
D) Hedging
Answer: D) Hedging
What does the “information ratio” measure?
A) The risk-adjusted return of an investment relative to its benchmark
B) The total return of a portfolio
C) The liquidity of an asset
D) The market risk of an investment
Answer: A) The risk-adjusted return of an investment relative to its benchmark
What is “downside risk”?
A) The potential for returns to exceed expectations
B) The risk associated with negative returns or losses
C) The risk of missing out on investment opportunities
D) The risk of interest rate increases
Answer: B) The risk associated with negative returns or losses
Which financial metric is often used to compare the risk-adjusted performance of different investments?
A) Sharpe ratio
B) P/E ratio
C) Dividend yield
D) Price-to-book ratio
Answer: A) Sharpe ratio
What does “total risk” include?
A) Systematic risk only
B) Unsystematic risk only
C) Both systematic and unsystematic risk
D) Liquidity risk only
Answer: C) Both systematic and unsystematic risk
Which of the following best describes “portfolio risk”?
A) The risk of an individual security
B) The total risk of a portfolio’s returns based on its composition
C) The risk-free rate of return
D) The risk of missing investment targets
Answer: B) The total risk of a portfolio’s returns based on its composition
What is “risk premium”?
A) The amount of risk-free return an investment provides
B) The additional return expected for taking on additional risk
C) The minimum return required by an investor
D) The fee charged for managing a risky investment
Answer: B) The additional return expected for taking on additional risk
Which of the following factors typically contributes to higher investment risk?
A) Long-term investment horizon
B) Low volatility
C) High financial leverage
D) High liquidity
Answer: C) High financial leverage
What is “systematic risk” also known as?
A) Market risk
B) Specific risk
C) Credit risk
D) Operational risk
Answer: A) Market risk
Which of the following would most likely lead to a decrease in an investment’s risk?
A) Increasing leverage
B) Adding more assets to the portfolio
C) Concentrating investments in one sector
D) Reducing diversification
Answer: B) Adding more assets to the portfolio
What does “return on investment” (ROI) measure?
A) The total risk of an investment
B) The percentage of profit or loss relative to the initial investment
C) The market value of an investment
D) The liquidity of an investment
Answer: B) The percentage of profit or loss relative to the initial investment
What is the “capital allocation line” (CAL)?
A) A graph showing the risk-return profile of different portfolios
B) A line representing the risk-free rate of return
C) A measure of an investment’s volatility
D) A line representing the cost of capital
Answer: A) A graph showing the risk-return profile of different portfolios
What does “beta” measure in terms of investment risk?
A) The total risk of an investment
B) The risk of an investment relative to the overall market
C) The liquidity risk of an investment
D) The credit risk of an investment
Answer: B) The risk of an investment relative to the overall market