UNIT 6 QBANK Flashcards
An investor chooses to have a portfolio made up of domestically listed U.S. securities only. In so doing, this investor is primarily avoiding which of the following two risks?
A) Market and purchasing power
B) Political and currency
C) Call and reinvestment
D) Inflation and interest rate
B) Political and currency
By having a portfolio made up of only domestically listed U.S. securities, the investor is primarily avoiding political risk and currency risk. Political risk is attributable to political instability, rarely associated with U.S. domestic markets. Currency risk is most prevalent when buying or selling involves a foreign currency that can fluctuate in value against the U.S. dollar. While these two are avoided, the investor could still be exposed to each of the other risks listed here.
Which types of investments are most susceptible to interest rate risks?
A) Money market instruments
B) Common stocks
C) Options
D) Bonds
D) Bonds
Bond prices move down when interest rates move up. Money market instruments can also be affected, but bonds are more impacted due to longer duration.
Which of the following statements best describes financial risk?
A) A risk generally caused by poor management and operating decisions
B) The risk that when interest rates decline, it is difficult to invest proceeds from redemptions
C) The risk that an issuer will be unable to meet interest and principal payments on debt obligations
D) The risk that a security with a call feature might be called before maturity
C) The risk that an issuer will be unable to meet interest and principal payments on debt obligations
Financial risk emanates from the use debt financing (leverage). It represents the potential inability to meet interest and principal payments on debt obligations, which can lead to bankruptcy. It is sometimes called credit risk or default risk.
Systematic risk would include all of the following except
A) business risk.
B) market risk.
C) interest rate risk.
D) inflation risk.
A) business risk.
Nonsystematic risks are those associated with the issuer (like a bad business strategy). Systematic risks impact large portions of the market and are difficult to reduce by diversification
Which of the following investments would be most susceptible to inflation risk?
A) 10-year corporate bond rated BBB
B) Value stock
C) 30-year Treasury bond
D) Growth stock
C) 30-year Treasury bond
Stocks generally have had performance that outpaces inflation. Lower quality bonds with shorter maturities would pay a higher rate than government bonds and have the potential to keep up with inflation. Treasuries have very low yields and do not keep pace with inflation.
All investors and investments are different. Recognizing this, it is true that
A) no investment should be deemed suitable for every investor.
B) most investments are not deemed suitable for any investor.
C) some investments can be suitable for all investors.
D) all investments can be deemed suitable for every investor.
A) no investment should be deemed suitable for every investor.
Because all investments are different, carrying different levels of risk and reward, no investment can ever be assumed as being suitable for all investors. Each investment type and/or strategy will be suitable for some investors but not all.
When investing in overseas markets in foreign securities, investors should be aware of and understand
A) reinvestment risk.
B) business risk.
C) currency risk.
D) market risk.
C) currency risk.
Whenever investing in securities issued in non-U.S. markets, investors need to be sensitive to the different risks that might apply to foreign investments. Of those listed here, currency risk should be of concern. Currency risk is the possibility that an investment denominated in a foreign currency could decline for U.S. investors if the value of that currency declines in its exchange rate with the U.S. dollar.
If the stock market were to fall substantially in a single day, a portfolio consisting primarily of common and preferred stock would be most subject to
A) market risk.
B) inflation risk.
C) regulatory risk.
D) reinvestment risk.
A) market risk.
Market risk is the risk that when the overall market declines, so too will any portfolio made of securities the market is composed of.
Some bonds have a feature that prohibits them from being called by the issuer before a certain date. This is known as
A) call protection.
B) interest-rate exposure.
C) financial risk.
D) capital risk.
A) call protection.
Some callable bonds have a feature known as call protection, which essentially limits the issuer from calling them in before a certain date. The length of the call is predetermined, and during this time, the investor knows that the bond cannot be called away.
Those holding the securities of a company where rules might change that impact or upset the way the company does business are exposed to
A) regulatory risk.
B) currency risk.
C) liquidity risk.
D) financial risk.
A) regulatory risk.
Changes in the overall regulatory climate or specific rule changes that impact an individual company’s business model can have an effect on the company’s performance or ability to operate profitably. Those holding the securities of such companies are exposed to regulatory risk.
A company is about to introduce a new product. While confident in the product’s appeal and market, it is still an unknown factor until sales results are viewed later. Investors holding stock in the company are at this time specifically exposed to
A) reinvestment risk.
B) financial risk.
C) business risk.
D) call risk.
C) business risk.
Business risk is an operating risk related to poor or untimely management decisions. Decisions regarding if and when to introduce new products are one example of those that might expose investors specifically to business risk.
Sovereign risk is the risk
A) that a country will default on its commercial debt obligations.
B) of losing all one’s investment due to a change in tax laws.
C) that interest rates decline in several countries simultaneously.
D) that a dollar earned today will not be able to purchase the same goods or services it can now in the future.
A) that a country will default on its commercial debt obligations.
Sovereign risk is when a country is at risk of defaulting on its commercial debt obligations. When this occurs, the impact is felt on financial markets worldwide.
Purchased 15 years ago with a coupon of 6.25%, a corporate bond in an investor’s portfolio has matured. With interest rates now substantially lower at 2.75%, this investor, having no immediate need for the proceeds, is now exposed to
A) reinvestment risk.
B) financial risk.
C) interest-rate risk.
D) call risk.
A) reinvestment risk.
The inability to invest proceeds from an investment that had been earning a higher rate of return, at the now current lower rate, is known as reinvestment risk.
An investor in the United States is purchasing a security traded on a foreign securities exchange. The transaction on the exchange is priced in euros. The circumstances of this purchase and subsequent sale of the security exposes the investor to
A) business risk.
B) currency risk.
C) liquidity risk.
D) financial risk.
B) currency risk.
Whenever investing abroad, investors may be exposed to a number of risks that would not occur when investing in the U.S. domestic markets. Currency risk, for example, is the possibility that an investment denominated in one currency could decline if the value of that currency declines in its exchange rate with the U.S. dollar.
What is one of the advantages for the investor who invests in mutual funds that include foreign securities in the fund’s portfolio?
A) Reduced business risk
B) Increased diversification
C) Higher dividends
D) Increased liquidity
B) Increased diversification
If an investor has a purely domestic mutual fund portfolio considered to be as fully diversified as possible, expanding into funds investing in foreign securities is an obvious route to further diversification. The other risks and advantages listed are not peculiar to foreign businesses or securities.
