Investment MCQ Solutions: Adwa Finance Magazine - 2

1. Which of the following is the most appropriate measure of a portfolio's risk?

- A) Expected return

- B) Standard deviation

- C) Beta

- D) Sharpe ratio

Correct Answer: B) Standard deviation

Explanation:

Standard deviation is a key measure of total risk in portfolio management, reflecting the volatility or variability of returns around the mean. It indicates how much the returns of an asset or portfolio deviate from the expected return, giving investors a sense of the overall uncertainty or risk. A higher standard deviation means greater risk because the portfolio's returns are more spread out, indicating more uncertainty about its performance.

- What it means for your investment journey: Understanding standard deviation helps you evaluate how risky a particular investment or portfolio is. For conservative investors, a low standard deviation is often preferred because it signifies more stable returns, while risk-tolerant investors might accept higher standard deviations in pursuit of higher returns.

2. If you are risk-averse, which of the following portfolios would you most likely choose?

- A) A portfolio with 70% stocks and 30% bonds

- B) A portfolio with 50% stocks and 50% bonds

- C) A portfolio with 30% stocks and 70% bonds

- D) A portfolio with 100% stocks

Correct Answer: C) A portfolio with 30% stocks and 70% bonds

Explanation:

Risk-averse investors prefer investments that have lower risk and less volatility. A portfolio with 70% bonds and 30% stocks is considered more conservative because bonds are generally less volatile than stocks and provide more stable returns. This type of portfolio is likely to have lower overall returns compared to a portfolio with a higher stock allocation, but it will also have lower risk, which appeals to risk-averse investors.

- What it means for your investment journey: If you’re cautious about losing money or can't handle large swings in your investment value, a portfolio with a higher allocation to bonds can provide a smoother ride with more predictable returns. However, it also means lower potential gains compared to portfolios with higher stock allocations.

3. What does asset allocation involve in investment management?

- A) Selecting individual stocks to invest in

- B) Determining the mix of asset classes like stocks, bonds, and cash

- C) Timing the market to buy low and sell high

- D) Reinvesting dividends for higher growth

Correct Answer: B) Determining the mix of asset classes like stocks, bonds, and cash

Explanation:

Asset allocation refers to how an investor divides their investment portfolio among different asset classes, such as stocks, bonds, and cash. The goal is to balance risk and reward according to the investor’s financial goals, risk tolerance, and investment horizon. Stocks offer higher returns but come with higher risk, while bonds and cash provide stability but lower returns.

- What it means for your investment journey: Proper asset allocation is key to managing risk and maximizing your returns. By diversifying across asset classes, you can reduce the risk of significant losses if one sector or market performs poorly. As your financial situation changes, you may need to adjust your asset allocation to stay aligned with your goals.

4. Which of the following is an example of an income-generating stock?

- A) A high-growth technology stock that reinvests earnings into expansion

- B) A utility company stock that pays consistent dividends

- C) A cyclical stock with fluctuating earnings

- D) A startup company with zero profits but high potential for growth

Correct Answer: B) A utility company stock that pays consistent dividends

Explanation:

Income-generating stocks are typically associated with companies that pay regular dividends to shareholders. Utility companies are a prime example because they have stable, predictable cash flows and often pay out a portion of their earnings as dividends. These stocks are appealing to investors who seek regular income rather than capital appreciation.

- What it means for your investment journey: If you're looking to generate steady income from your investments, focusing on dividend-paying stocks, such as utilities or other income-focused sectors, can provide regular cash flow. This is particularly valuable for retirees or those who need predictable income streams.

5. Which of the following is a strategy to minimize risk by spreading investments across different asset classes?

- A) Market timing

- B) Diversification

- C) Leverage

- D) Short selling

Correct Answer: B) Diversification

Explanation:

Diversification is the practice of spreading your investments across various asset classes (like stocks, bonds, and cash) and within each class (such as investing in different industries or regions). By doing this, you reduce the risk that poor performance in one asset class or stock will significantly hurt your overall portfolio. It’s a cornerstone of sound investment strategy.

- What it means for your investment journey: Diversification helps protect your portfolio from the full impact of market downturns. Instead of "putting all your eggs in one basket," you spread your investments, so even if one sector or asset class underperforms, others may compensate and help you maintain overall stability.

To learn more in detail about these concepts and how they apply to your personal investment strategy, visit (AdwaTransformation.com)