5.2 Financial Risk and Return Flashcards
The risk of loss because of fluctuations in the relative value of foreign currencies is called
A. Expropriation risk.
B. Multinational beta.
C. Exchange rate risk.
D. Undiversifiable risk.
Your answer is correct.
When amounts to be paid or received are denominated in a foreign currency, exchange rate fluctuations may result in exchange gains or losses. For example, if a U.S. firm has a receivable fixed in terms of units of a foreign currency, a decline in the value of that currency relative to the U.S. dollar results in a foreign exchange loss.
The type of risk that is not diversifiable and affects the value of a portfolio is
A. Purchasing-power risk.
B. Market risk.
C. Nonmarket risk.
D. Interest-rate risk.
Your answer is correct.
Prices of all stocks, even the value of portfolios, are correlated to some degree with broad swings in the stock market. Market risk is the risk that changes in a stock’s price will result from changes in the stock market as a whole. Market risk is commonly referred to as nondiversifiable risk.
The marketable securities with the least amount of default risk are
A. Federal government agency securities.
B. U.S. Treasury securities.
C. Repurchase agreements.
D. Commercial paper.
B. U.S. Treasury securities.
The marketable securities with the lowest default risk are those issued by the federal government because they are backed by the full faith and credit of the U.S. government and are therefore the least risky form of investment.
Which of the following classes of securities are listed in order from lowest risk/opportunity for return to highest risk/opportunity for return?
A. U.S. Treasury bonds; corporate first mortgage bonds; corporate income bonds; preferred stock.
B. Corporate income bonds; corporate mortgage bonds; convertible preferred stock; subordinated debentures.
C. Common stock; corporate first mortgage bonds; corporate second mortgage bonds; corporate income bonds.
D. Preferred stock; common stock; corporate mortgage bonds; corporate debentures.
A. U.S. Treasury bonds; corporate first mortgage bonds; corporate income bonds; preferred stock.
The general principle is that risk and return are directly correlated. U.S. Treasury securities are backed by the full faith and credit of the federal government and are therefore the least risky form of investment. However, their return is correspondingly lower. Corporate first mortgage bonds are less risky than income bonds or stock because they are secured by specific property. In case of default, bondholders can have the property sold to satisfy their claims. Holders of first mortgages have rights paramount to those of any other parties, such as holders of second mortgages. Income bonds pay interest only in the event the corporation earns income. Thus, holders of income bonds have less risk than shareholders because meeting the condition makes payment of interest mandatory. Preferred shareholders receive dividends only if they are declared, and the directors usually have complete discretion in this matter. Also, shareholders have claims junior to those of debtholders if the enterprise is liquidated.
