Unit 7 Risk and Recommendations

Question 1

_____ is the risk that changes in the overall economy will have an adverse effect on individual securities, regardless of the company’s circumstances. It is generally caused by factors that affect all businesses, such as war, global security threats, or inflation.

Answer 1

Systematic risk

Question 2

No matter how diversified a portfolio of investments is, it will still be subject to _____

Answer 2

systematic risk.

Question 3

Types of Systematic Risk:

Answer 3

Market Risk
Interest Rate Risk
Reinvestment Risk
Inflation Risk
Currency Risk

Question 3

_____ is the risk that a bond might be called before maturity and an investor will be unable to reinvest the principal at a comparable rate of return.

Answer 3

Call risk

Question 4

______risk is defined as a potential change in bond prices caused by a change in market interest rates.

Answer 4

Interest rate

Question 5

_______ risk is a variation on interest rate risk. When interest rates decline, it is difficult to reinvest proceeds from redemptions, securities that have beencalled (call risk),
or investment distributions while maintaining the same level of income without taking on additional risk.

Answer 5

Reinvestment

Question 6

_______ is the effect of continually rising prices on a fixed investment income. If an investment’s income is a fixed amount, the purchasing power of the income diminishes over time.

Answer 6

inflation risk

Question 7

______ is the possibility that an investment denominated in a foreign currency
could decline if the value of that currency declines in its exchange rate with the U.S. dollar.
Fluctuating currency exchange rates become an important consideration whenever investing in a foreign security or any security denominated in a foreign currency.

Answer 7

Currency risk

Question 8

_____ is the risk that a bond might be called before maturity and an investor will be unable to reinvest the principal at a comparable rate of return. Which can lead to an lead to reinvestment risk,

Answer 8

Call risk

Question 9

______ can be reduced through diversification. It is risk that is unique to a specific industry, business, or investment type.

Answer 9

Non systematic risk (you may also see the term unsystematic risk)

Question 10

Types of Nonsystematic Risk:

Answer 10

Default Risk (Financial Risk, Credit Risk)
Business Risk
Prepayment Risk
Liquidity Risk
Regulatory Risk
Legislative Risk
Political Risk
Sovereign Risk

Question 11

______ risk is the potential for an investor to lose some or all of their money-their invested
capital under circumstances related to an issuer’s financial strength. Default risk includes the risk that a debt security will fail to make interest payments.This risk is most commonly associated with debt securities.

Answer 11

Default

Question 12

______ is an operating risk, generally caused by poor management decisions. At best, earnings are lowered; at worst, the company goes out of business and common stockholders could lose their entire investment.

Answer 12

Business risk

Question 13

______ is the risk that a borrower will repay the principal on a loan or debt instrument (bond) before its maturity and thus deprive the lender of future interest payments. EX: GNMA loans

Answer 13

Prepayment risk

Question 14

The risk that an investor might not be able to sell an investment quickly at a fair market price is known as ______

Answer 14

liquidity risk or marketability risk

Question 15

Regulatory Risk:

Answer 15

A sudden change in the regulatory climate can have a dramatic effect on the performance of a business and entire business sectors. Changes in the rules that a business must comply with can devastate individual companies and industries almost overnight.
Common examples of this risk are rulings made by the Environmental Protection Agency (EPA) or the Food and Drug Administration (FDA). Changes to rules that affected businesses have to follow can sometimes upsettheir business models and their ability tobe profitable.

Question 16

Changes to the tax code are the most obvious _______ risk

Answer 16

legislative risks

Question 17

_____ risk ratings capture the risk of a country defaulting on its debt obligations. When a country is at risk of defaulting on its debt, the impact is felt on financial markets worldwide.

Answer 17

Sovereign

Question 18

Mitigating Systematic Risk:

Answer 18

Systematic risk is risk that is built into the system. The only way to mitigate or hedge systematic risk is to find an asset that will move in the opposite direction of the markets as a whole. Portfolio managers will use derivative securities to hedge the portfolio risk.

Question 19

Mitigating Nonsystematic Risk can be reduced through ____

Answer 19

diversification.

Question 19

When an R (or other associated person) provides information that a reasonable person would view as suggesting a course of action regardinga security, a class of investment, or an investment strategy, that person is making a _________

Answer 19

recommendation

Question 20

Financial Considerations: If a circumstance may be easily quantified as an amount of
money (either a lump sum or a stream of payments), it is likely a financial circumstance. Examples:

Answer 20

Income
Value oftheir home
Liquid net worth
Debt payments
Total debt

Question 21

Nonfinancial Circumstances Include:

Answer 21

the customer’s age;
the customer’s marital status;
the number and ages of the customer’s dependents;
the customer’s employment status; and
the employment of the customer’s immediate family members.

Question 22

A customer’s ____ are other important considerations that will shape his portfolio. To understand a customer’s attitude about investment alternatives, the representative or adviser should ask the customer the following questions to complete the customer profile and know the customer.

Answer 22

risk tolerance and investment goals

Question 23

_____ established a new standard of conduct under the Securities Exchange Act of 1934 for broker-dealers (BDs) and associated persons of a BD when making a recommendation of any securities transaction or investment strategy involving securities (including account recommendations) to a retail customer.

Answer 23

Regulation BI (Regulation Best Interest (BI))

Question 23

Regulation BI (Regulation Best Interest (BI) requires any member or associated person making a recommendation must exercise reasonable diligence, care, skill, and prudence in making the recommendation by doing the following:

Answer 23

Acknowledging the potential risks, rewards, and costs associated with a recommendation
Acting in the best interest of a particular customer based on that retail customer’s personalized investment profile
Believing that a series of recommendations, while in the customer’s best interest when viewed in isolation, is not excessive and unsuitable for the customer when taken as a whole
Identifying conflicts of interest such as sales contests or bonuses based on the results of a recommendation-and disclosing and mitigating them, or eliminating them

Question 24

The general obligation to act in the customer’s best interest is satisfied only if you comply with four specified component obligations:

Answer 24

Disclosure Obligation, Care Obligation, Conflict of Interest Obligation, and Compliance Obligation.

Question 25

Factors considered in determining whether a recommendation has taken place include:

Answer 25

whether the communication “reasonably could be viewed as a ‘call to action’” and “reasonably would influence an investor to trade a particular security or group of securities.”

Question 26

The Disclosure Obligation: Members must, prior to or at the time of the recommendation, provide the retail customer, in
writing, full and fair disclosure of:

Answer 26

all material facts relating to the scope and terms of the relationship with the retail customer;
material fees and costs that apply to the retail customer’s transactions, holdings, and accounts;
the type and scope of the services to be provided to the retail customer, including any material limitations on the securities or investment strategies that may be recommended to the retail customer; and
all material facts relating to conflicts of interest that are associated with the recommendation.

Question 27

Under the Care Obligation, members must exercise reasonable ____, _____, and ____
when making a recommendation to a retail customer.

Answer 27

diligence, care, and skill

Question 28

Under the _____ a BD must establish, maintain, and enforce written policies and procedures reasonably designed to address conflicts of interest associated with its recommendations to retail customers.

Answer 28

Conflict of Interest Obligation:

Question 29

The SEC presumes that the use of the terms ‘adviser’ and ‘advisor’ in a name or title by (i) a broker-dealer that is not also registered as an investment adviser or (il) an associated person that is not also a supervised person of an investment adviser to be a violation of the capacity disclosure requirement under _____

Answer 29

Regulation Best Interest.

Question 30

Identify the major market benchmarks and indices:

Answer 30

Dow Jones Industrial Average (DJIA).
Standard & Poor’s (S&P) 500 Index.
Russell 2000 Index.
Wilshire 5000- TOTAL US STOCK MARKET
Bloomberg Barclays U.S. Aggregate Bond Index.
MSCI EAFE Index.

Question 31

Blue chip index:

Answer 31

Dow Jones Industrial Average (DJIA).

Question 32

LArge cap Index:

Answer 32

Standard & Poor’s (S&P) 500 Index.

Question 33

Small cap index

Answer 33

Russell 2000 Index.

Question 34

Total US Stock Market Index

Answer 34

Wilshire 5000 Index

Question 35

Investment grade bond index:

Answer 35

Bloomberg Barclays U.S. Aggregate Bond Index.

Question 36

largest foreign stock index:

Answer 36

MSCI EAFE Index.

Question 37

Major Market Indices cover:

Answer 37

Equities
Bonds
Foreign Stocks

Question 38

3 Topics to making suitable recommendations

Answer 38

Check the foundation
Financial Considerations
NonFinancial Considerations

Question 39

Regualtion Best Interest:

Answer 39

Disclosure of Obligation
Care Obligation
Conflict of interest obligation
Compliance Obligation

Question 40

Scope and terms of the relationship
fees and cost
type and scope of services
material facts relating to conflicts

Answer 40

Disclosure Obligation

Question 41

Risks, rewards, and costs
Reasonable basis
series of recommended transactions

Answer 41

Care Obligation

Question 42

Identify and mitigate conflicts in recommendations
Eliminate special compensation for specific securities

Answer 42

Conflict of Interest Obligation

Question 43

The compliance obligation is a firm-level obligation
Specific rules not tested on the SIE
Principal level knowledge

Answer 43

Compliance Obligation

Question 44

A company that is extensively overleveraged using debt financing whenever available would be exposing its investors to

Answer 44

financial risk

Question 45

When interest rates are falling, which bonds are most likely to expose holders to call risk?

Answer 45

When interest rates fall, issuers will call in their callable debt issues with the highest coupon rates first. These are the ones currently costing the issuer the most in interest payments. Therefore, when interest rates are falling, holders of higher coupon bonds are more exposed to call risk than are those investors holding lower coupon bonds.

Question 46

For investors, instability within an emerging economy is generally recognized as

Answer 46

political risk

Question 47

Political risk is more associated with

Answer 47

emerging economies, but could occur even in highly developed ones.

Question 48

what is not required for a communication to be considered a recommendation?

Answer 48

The intention to make a recommendation

Question 49

_____ 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.

Answer 49

Sovereign

Question 50

Call risk is most closely associated with

Answer 50

reinvestment risk

Question 51

Which type of securities are most susceptible to business risk?

Answer 51

common stock

Question 52

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

Answer 52

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.