F i n a n c e & I n v e s t m e n t C l u b

i i m r o h t a k
Finance & Investment Club | IIM Rohtak

FAQs

TECHNICAL QUESTIONS

Q1. What are the different types of financial assets?

Financial assets include stocks, bonds, real estate, derivatives, and commodities. Stocks
represent ownership in a company, while bonds are loans to entities like governments or
corporations. Real estate refers to physical property, while derivatives derive value from
underlying assets (e.g., options, futures). Commodities are tangible resources like gold or oil.
Each asset has its risk-return profile, and investors choose a mix based on objectives and risk
tolerance.

Q2. Explain the concept of asset allocation. How do you determine the right asset
allocation strategy?

Asset allocation is the process of dividing investments across various asset classes to manage
risk and maximize returns. The right strategy depends on factors like the investor’s risk
tolerance, time horizon, and financial goals. For instance, younger investors may opt for a
higher proportion of stocks for long-term growth, while older investors might prefer bonds for
stability. Diversification helps spread risk across asset classes.

Q3. How would you value a company? What are the different methods of valuation?

Companies can be valued using methods like Discounted Cash Flow (DCF), Comparable
Company Analysis, and Precedent Transactions. DCF values a company based on its future
cash flows discounted to present value. Comparable analysis compares the company’s
valuation metrics to similar firms, while precedent transactions look at valuations in past
acquisitions. The method used depends on data availability and the industry.

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Q4. What is the difference between active and passive asset management? Which do you
think is more effective?

Active management involves selecting investments to outperform a benchmark, while passive

management tracks an index. Active managers use research and timing strategies, but they
charge higher fees and may underperform. Passive strategies have lower costs and often
perform better in efficient markets. Effectiveness depends on market conditions—active
management may add value in inefficient markets, while passive management often works
well in developed markets.

Q5. Can you explain the concept of Modern Portfolio Theory? How does it help in asset
management?

Modern Portfolio Theory (MPT) emphasizes diversifying investments to maximize returns for
a given level of risk. It shows that a portfolio’s risk is not just the sum of individual asset risks
but is reduced through proper diversification. MPT helps asset managers construct portfolios
with the highest expected return for a specific risk tolerance, encouraging investors to focus
on overall portfolio performance rather than individual securities.

Q6. What is risk management in the context of financial asset management? How would
you mitigate risks in a portfolio?

Risk management involves identifying, assessing, and mitigating potential losses in a portfolio.
It includes diversification across asset classes, geographic regions, and industries to reduce
exposure to specific risks. Techniques like hedging, using derivatives, and adjusting asset
allocation can mitigate risks. Regular portfolio reviews and stress testing also ensure the
portfolio aligns with the investor’s risk tolerance and financial goals.

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Q7. Explain the significance of beta and alpha in portfolio management.

Beta measures an asset's volatility compared to the overall market. A beta greater than 1
indicates higher volatility, while a beta less than 1 means less volatility. Alpha represents the
excess return a portfolio generates relative to a benchmark. Positive alpha indicates
outperformance, while negative alpha suggests underperformance. In portfolio management,
beta helps manage risk, while alpha assesses the effectiveness of the manager’s strategy.

Q8. What are derivatives, and how are they used in financial asset management?

Derivatives are financial contracts whose value is derived from underlying assets like stocks,
bonds, or commodities. Common types include options, futures, and swaps. In asset
management, derivatives are used for hedging risks, speculating on asset price movements, or
enhancing portfolio returns. For example, options can protect against downside risk in a
portfolio, while futures can be used to gain exposure to commodities.

Q9. What is the Sharpe Ratio, and why is it important in portfolio management?

The Sharpe Ratio measures risk-adjusted returns by comparing a portfolio’s excess return (over
the risk-free rate) to its standard deviation. It’s used to evaluate whether an investment’s returns
justify the risks taken. A higher Sharpe Ratio indicates better risk-adjusted performance.
Portfolio managers use it to compare investments or portfolios, helping them select assets that
offer the best returns relative to risk.

Q10. How do interest rate changes impact asset management strategies?

Interest rate changes directly affect asset prices, especially bonds. When rates rise, bond prices
fall, reducing returns for bondholders. Conversely, falling rates increase bond prices. Equity
markets can also be affected as higher rates increase borrowing costs and reduce corporate
profits. In asset management, strategies may shift between asset classes, like moving from
bonds to equities during periods of rising rates or vice versa.

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Q11. What is the difference between a bond's yield to maturity and its coupon rate?

The coupon rate is the fixed annual interest a bond pays, expressed as a percentage of its face
value. Yield to maturity (YTM) is the total return an investor can expect if the bond is held
until maturity, considering both the coupon payments and any capital gain or loss from
purchasing the bond at a price other than its face value. YTM accounts for the bond’s current
price, making it a more comprehensive measure.

Q12. Explain the concept of Efficient Market Hypothesis (EMH). Do you believe markets
are fully efficient?

The Efficient Market Hypothesis (EMH) states that financial markets fully reflect all available
information, making it impossible to consistently achieve above-average returns through
stock-picking or market timing. Markets are considered efficient in the sense that prices adjust
rapidly to new information. However, while EMH has strong empirical support, behavioral
finance suggests that markets may not always be fully efficient due to human biases and
irrational behaviors.

Q13. What is a hedge fund, and how does it differ from a mutual fund?

Hedge funds are investment vehicles that pool capital from accredited investors to investing a
wide range of assets using aggressive strategies, including leverage, derivatives, and short
selling. They aim for absolute returns regardless of market conditions. Mutual funds, on the
other hand, are more regulated and accessible to retail investors, investing in stocks, bonds, or
other securities with a goal of long-term growth. Hedge funds are more flexible but riskier,
while mutual funds are more regulated and typically have lower risks.

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Q14. How do you evaluate the performance of a portfolio manager?

Portfolio managers are evaluated based on their ability to generate risk-adjusted returns,
typically using metrics like alpha, Sharpe ratio, and beta. Consistency in outperforming the
benchmark, adherence to the investment strategy, and the ability to navigate various market
conditions are key factors. Managers should also be assessed on risk management, cost-
efficiency, and transparency in reporting performance. Peer comparisons and client feedback
provide additional insights into a manager’s effectiveness.

Q15. What is quantitative easing, and how does it affect asset prices?

Quantitative easing (QE) is a monetary policy tool used by central banks to inject liquidity into
the economy by purchasing government bonds and other financial assets. By increasing the
money supply, QE lowers interest rates and encourages borrowing and investment. Lower rates
tend to drive up asset prices, particularly stocks and bonds, as investors seek higher returns in
a low-yield environment. QE can also devalue a currency, boosting exports and equity markets.

Q16. Explain the difference between systematic and unsystematic risk.

Systematic risk, also known as market risk, is the risk inherent to the entire market or market
segment and cannot be diversified away (e.g., economic recessions, inflation). Unsystematic
risk, or specific risk, pertains to individual companies or industries and can be reduced through
diversification. Examples include company management issues or product failures. Managing
unsystematic risk involves holding a diversified portfolio, while systematic risk requires
macro-level strategies like hedging.

Q17. What is duration, and how is it used in bond portfolio management?

Duration measures the sensitivity of a bond’s price to changes in interest rates. Specifically, it
estimates how much a bond’s price will change for a 1% change in interest rates. Bonds with
longer durations are more sensitive to interest rate fluctuations. In portfolio management,

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duration helps managers assess interest rate risk. By adjusting the average duration of their
bond portfolio, managers can align with their interest rate outlook, either reducing or increasing
risk exposure.

Q18. Can you explain the concept of Value at Risk (VaR)? How is it calculated, and what
are its limitations?

Value at Risk (VaR) estimates the potential loss in value of a portfolio over a specific time
frame for a given confidence level (e.g., 95%). It can be calculated using historical data,
variance-covariance, or Monte Carlo simulations. Despite its widespread use, VaR has
limitations, such as assuming normal distribution of returns and not accounting for extreme
market events (tail risks). It provides no insight into the magnitude of losses beyond the VaR
threshold.

Q19. What is the role of a financial analyst in asset management?

A financial analyst in asset management conducts research and analysis on various investment
opportunities, helping portfolio managers make informed decisions. They assess market
trends, evaluate financial statements, forecast future performance, and provide insights on
economic conditions. Their role is crucial in developing investment strategies, managing risks,
and identifying potential investments. Financial analysts also monitor portfolio performance
and recommend adjustments to align with the investment goals.

Q20. What are the key economic indicators you would monitor when managing a global
portfolio?

Key economic indicators for managing a global portfolio include GDP growth rates,
inflation,interest rates, unemployment data, and central bank policies. Trade balances, currency
exchange rates, and geopolitical events are also important. Monitoring stock market indices,
bond yields, and commodity prices helps assess financial market conditions. Country-specific

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factors like fiscal policy, political stability, and corporate earnings reports also play a role in
global portfolio management decisions.

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