UNIT 6 CHECKPOINT EXAM Flashcards
Five years ago Thompson, an investor, ran across a board game that he enjoyed and believed the game would become very popular. He purchased 1,000 shares of the corporation that publishes the game. Unfortunately, the game was too complex for most casual game players and sales never amounted to much. Over the five years, the stock of the publisher has remained steady, but has not increased in value. This is an example of
A) regulatory risk.
B) social risk.
C) timing risk.
D) business risk.
D) business risk.
The failure of the game is an example of business risk. As a business venture the publisher did not do well. Timing and regulation had nothing to do with the failure. Social risk assumes a change in societal attitudes, in this case, there was no change, and the publisher and Thompson just read the market wrong.
Your customer, Ivan, owns a diversified portfolio of large cap stocks. He would like to find a way to hedge the market risk in his portfolio. Which of these actions might you recommend to accomplish his goal?
A) Buy S&P 500 index puts to hedge market risk.
B) Tell him to do nothing because there is no way to mitigate systematic risk.
C) Diversify his portfolio further.
D) Sell all his stocks and wait for a better time.
A) Buy S&P 500 index puts to hedge market risk.
Your customer is worried about market risk, a systematic risk. Further diversifying his portfolio will not help. Selling everything is likely not helping, and means he may miss any upward moves while he is waiting it out. Derivatives like options (index puts in this case) may be used to offset market risk.
A strategy that blends various types of investment in an effort to reduce nonsystematic risk is called
A) diversification.
B) capital preservation.
C) dollar cost averaging.
D) sector rotation.
A) diversification.
Nonsystematic risk occurs based on circumstances or events that are unique to a specific security. This risk can be managed by diversifying the assets in a portfolio by selecting securities that possess different risk and/or return characteristics.
New Haven Farms is a producer of specialty foods. They recently received a notice that the Wetlands Maintenance and Drainages Act (The WMD Act) passed indicates that a significant portion of their current land used in food production falls under the act’s protection and may no longer be used for agriculture. This is an example of
A) legislative risk.
B) regulatory risk.
C) political risk.
D) business risk.
A) legislative risk.
The best answer is legislative risk, as this was caused by a change in the law. Regulatory risk is a change in the application of existing rules, while political risk is normally associated with a change in leadership. Business risk would be a bad business plan, not a working business plan damaged by changing laws.
A risk that is specific to a particular issue or issuer is
A) is a systematic risk.
B) cannot be reduced by diversification.
C) impacts a broad group of securities equally.
D) a nonsystematic risk.
D) a nonsystematic risk.
A risk that is specific to a particular issue or issuer is part of the definition of nonsystematic risk. It may be mitigated by diversification.
Kamron owns a diversified portfolio of stocks. The portfolio holds 58 different stocks that are diversified by market capitalization and sector as well as industry. When the stock market entered a significant downward correction Kamron’s portfolio also dropped. This is an example of which of these?
I. Market risk
II. Business risk
III. Systematic risk
IV. Unsystematic risk
A) II and IV
B) I and IV
C) I and III
D) II and III
C) I and III
I. Market risk
III. Systematic risk
This example represents a market risk and a systematic risk.
The inverse relationship between interest rates and bond prices helps in understanding that interest rate fluctuations are
A) the difference between credit and financial risk.
B) an example of regulatory risk.
C) a systematic risk for bonds.
D) an unsystematic risk for bonds.
C) a systematic risk for bonds.
The inverse relationship illustrates a significant systematic risk for bonds and other fixed-income investments. When rates move up all bonds move down. Credit and financial risk are largely synonymous terms. Interest rate risk is not a regulatory risk.
The risk that a stock will not appreciate in value due to poor cash flow is an example of
A) market risk.
B) nonsystematic risk.
C) systematic risk.
D) sales risk.
B) nonsystematic risk.
This is an issue that applies to just this issuer; a nonsystematic risk.
Systematic risk is
A) not reduced by diversification within an asset class.
B) associated with equity investments.
C) associated with debt instruments.
D) may be significantly reduced by diversification within an asset class.
A) not reduced by diversification within an asset class.
Systematic risk is risk that remains despite diversification. Examples include market risk and interest rate risk.
Risk that prevails despite diversification within an asset class is
A) call risk.
B) unsystematic risk.
C) business risk.
D) systematic risk.
D) systematic risk.
Risk that prevails despite diversification is one of the defining characteristics of systematic risk.
