Capital market theory and factor models: NISM Series XXI-B notes and practice questions

Q1. Which term is described here? The CML shows the risk-return trade-off of efficient portfolios that combine the risk-free asset with the market portfolio.

1. Bond immunisation
2. Top-down analysis
3. Capital market line
4. Portfolio manager defined

Q2. Which statement best describes “Beta”?

1. P/B compares market price to book value per share and is often used for banks and asset-heavy firms.
2. Beta measures a security's sensitivity to market movements, with a beta above 1 meaning more volatile than the market.
3. Credit risk is the risk that the issuer fails to pay interest or principal, which credit ratings help assess.
4. Standard deviation measures how widely returns vary around their average and is the common measure of total risk.

Q3. Which term is described here? The SML plots expected return against beta, and securities above the line are undervalued.

1. Security market line
2. Benchmark selection
3. Principal officer
4. Upfront fees

Q4. Which statement best describes “Market risk premium”?

1. Risk limits, such as caps on single-stock and sector exposure, keep the portfolio within the client's agreed risk profile.
2. SEBI requires portfolio manager performance to be reported on a uniform basis, with returns computed using TWRR through a central platform.
3. Hedging uses derivatives to reduce an existing risk, such as selling futures against a stock portfolio.
4. The market risk premium is the expected return of the market over the risk-free rate.

Q5. Which statement best describes “Multi-factor models”?

1. A random walk means price changes are unpredictable because new information arrives randomly.
2. A passive strategy replicates an index to match its return at low cost without trying to outperform.
3. Multi-factor models explain returns with several factors, such as size, value and momentum, in addition to the market.
4. Stress testing evaluates portfolio losses under extreme but plausible scenarios, complementing statistical measures.

Q6. Which statement best describes “CAPM”?

1. Exchange-traded derivatives require margin as a deposit that covers possible losses, and it is adjusted with price moves.
2. CAPM says expected return equals the risk-free rate plus beta times the market risk premium.
3. A bond's coupon is the interest paid on its face value, and the face value is repaid at maturity.
4. DCF values a business as the present value of its expected future cash flows, discounted at a rate reflecting risk.