Unit 6 (risks)

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) currency risk. B) financial risk. C) liquidity risk. D) business risk.

A) 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.

When investing in overseas markets in foreign securities, investors should be aware of and understand A) currency risk. B) market risk. C) reinvestment risk. D) business risk.

A) 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. dollars

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) reinvestment risk. D) regulatory 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.

An investor owns a bond purchased several years ago yielding 3%, which at the time was considered a fair return. However, these fixed 3% interest payments have not kept up with the inflation rate. This situation presents the investor with A) purchasing power risk. B) liquidity risk. C) financial risk. D) currency risk.

A) purchasing power risk. Inflation can generally be associated with diminished purchasing power—purchasing power risk. During times of inflation, a dollar will not be able to purchase what it had previously in the way of goods and services. Investments such as bonds paying fixed rates of return are negatively impacted during these times.

Inflation risk is most closely associated with A) purchasing power risk. B) call risk. C) interest-rate risk. D) nonsystematic risk.

A) purchasing power risk. When prices are rising (inflation), purchasing power is reduced. During inflationary periods, a dollar today often doesn't purchase the quantity of goods and services it purchased yesterday.

Call risk is most closely associated with A) reinvestment risk. B) market risk. C) currency risk. D) financial risk.

A) reinvestment risk. Call risk is the risk that a bond might be called before maturity. Often when this occurs, investors who receive their principal back sooner than anticipated are left to find ways to reinvest that will achieve the same returns—reinvestment risk.

Examples of investments in assets that would be considered illiquid would be all of the following except A) works of art. B) common stock. C) real estate. D) classic automobiles.

B) common stock. Investments in stocks and bonds are considered fairly liquid, while investments in fixed assets like real estate, art or collectibles are not, and therefore relatively illiquid.

The ability to take the proceeds from the redemption of one security or investment and allocate those proceeds in such a way so as to maintain the same level of return is expressed in which of the following concepts? A) Purchasing power risk B) Reinvestment risk C) Interest-rate risk D) Market risk

B. Reinvestment risk The concept of reinvestment risk has to do with the ability to reinvest proceeds from one sale or redemption while still maintaining the same yield or return. This is difficult to do in times when interest rates are falling.

Prepayment risk is associated with which type of securities? A) Corporate bonds B) Treasury bonds C) GNMA D) Municipal bonds

C) GNMA GNMAs are mortgage back securities; if homeowners pay off their mortgages early, mortgage backed securities are subject to prepayment 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) call risk. C) business risk. D) financial 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.

The effect of continually rising retail prices on the investment returns of one's portfolio is best described as A) reinvestment risk. B) call risk. C) inflation risk. D) business risk.

C) inflation risk. Inflation, or continually rising prices, reduces the purchasing power that one's investment returns will have. This is the essence of inflation risk.

For investors, instability within an emerging economy is generally recognized as A) currency risk. B) business risk. C) political risk. D) regulatory risk.

C) political risk. While political risk can be interrelated with legislative risk, most attribute this risk specifically to the potential instability in the political underpinnings of a country or economy. This risk is often associated with emerging economies, though it can potentially exist anywhere.

Which of the following accurately characterizes capital risk? A) It is minimal when investing in derivatives, such as options. B) It is the potential for loss due to an issuer's financial strength. C) It can be reduced by diversification. D) It is always high when investing in government securities.

C. It can be reduced by diversification. Capital risk is one of the nonsystematic risks that can be reduced by diversification. It represents the potential for loss due to circumstances unrelated to an issuer's financial strength. While it is considered minimal to none for U.S. government securities, it is generally high for derivative products, such as options.

Which of the following investments would be most susceptible to inflation risk? A) Value stock B) 10-year corporate bond rated BBB C) Growth stock D) 30-year Treasury bond

D) 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.

The risk that an investor might not be able to sell an investment quickly and at a fair market price is known as A) financial or default risk. B) call or reinvestment risk. C) inflation or purchasing power risk. D) liquidity or marketability risk.

D) liquidity or marketability risk. Having investments that are liquid means being able to divest of them quickly at a fair price. Liquidity risk comes for investors holding assets where doing that might not be possible.