Series 65: Unit 19

If the Federal Reserve increases interest rates dramatically, the market price of all bonds, regardless of credit quality, will (<,>)?

> decrease

Listed stocks and mutual funds have virtually no liquidity risk. Thinly traded stocks, many municipal bonds, and most tangible assets have a greater degree of inability to liquidate rapidly at your price.

NOTE

Whereas regulatory risk comes from a change in _________, legislative risk results from a change in the ______.

Regulations Law

6 primary unsystematic risks:

Business Financial (credit/default) Legislative Liquidity (marketability) Political Regulatory

The common stock of companies within which industry sector would be most adversely affected by an increase in the general level of interest rates? The clothing industry The food industry The electronics industry The utilities industry

D

________ (systematic risk, purchasing power risk) cannot be diversified away

Market risk

You should know that the primary systematic risks are the following, represented by the mnemonic PRIME:

Purchasing power (inflation) Reinvestment Interest rate Market Exchange rate (currency)

Liquidation priority:

Secured creditors (e.g., mortgage bonds, equipment trust certificates, collateral trust bonds). These may be called senior debt or even senior notes on the exam. Unsecured creditors (e.g., general creditors including debenture holders) Subordinated debt holders Preferred stockholders Common stockholders

When the 91-day Treasury bill rate is 3%, an investor decides to purchase a 20-year corporate bond at par with a coupon of 8%. If the corporate bond does not pay as expected, the investor's potential loss is considered Purchasing power risk Market cost Opportunity cost Duration risk

C

If a sovereign government enacted legislation that prohibited the sale of a certain product, companies who manufacture that product would likely see the price of their stock drop. This is an example of Business risk Credit risk Legislative risk Sovereign risk

C

When a corporation files for bankruptcy, heading the priority for payment would be holders of Commercial paper Senior prior lien preferred stock Common stockholders Senior debt

D

The risk that the value of an investment in a limited partnership will decline because of a change in tax law that disallows favored tax treatment for oil exploration costs is called Interest rate risk Legislative risk Market risk Liquidity risk

B

When an investor is faced with several choices, each with different levels of risk, the decision as to which to purchase opens the investor to Call risk Decision risk Behavioral modification Opportunity Cost

D

Of the many different types of risk faced by investors in securities, the systematic risk that first comes to mind for most is Inflation risk Interest rate risk Purchasing power risk Market risk

D. Systematic risk=market risk

Which of the following securities is considered the most senior? Subordinated debenture T stock Common stock Senior lien prior preferred stock

A. Regardless of how many adjectives are in front of the preferred stock, equities are always junior to debt. This is true even when the debt is a subordinated debenture. This debt is subordinate (comes behind) all other debt of the issuer, but, as a debt, it comes ahead of any equity security. Treasury stock is not issued by the U.S. Treasury (you cannot buy stock in America, regardless of what the ads for savings bonds say).

If a business fails because a new technology makes its products obsolete, this is an example of Unsystematic risk Inflation risk Systematic risk Interest rate risk

A. Unsystematic risk is a risk that is specific to a company or industry, while systematic risk, also known as market risk, is a risk that affects the entire market. Systematic=market risk

Under modern portfolio theory, MPT, which of the following types of risk cannot be eliminated through diversification? Credit risk Systematic risk Business risk Liquidity risk

B

All of the following risks are considered diversifiable except default risk. liquidity risk. purchasing power risk. sovereign risk.

C. Purchasing power risk, also known as inflation risk, is a systematic risk and, as such, is one that cannot generally be lessened through diversification.

Whippet Bus Lines, Inc., serving most of the country, has just been informed by the Surface Transportation Board of the United States that all of its buses must be retrofitted with expensive safety equipment. The effect of this will be a significant drop in Whippet's net income. To an investor in Whippet Bus Lines, Inc., this would be an example of Market risk Regulatory risk Country risk Business risk

B

A portfolio that is primarily invested in corporate bonds would be subject to Credit risk Interest rate risk Opportunity cost Purchasing power risk I & II I, II, III, & IV II & IV I, II, & IV

B

If interest rates are dropping, an investor with a maturing bond will be most concerned with the quality declining with the yield the difficulty in finding another investment with a like yield a negative yield curve a positive yield curve

B

The Federal Reserve Board has just taken action leading to an increase in interest rates. Which of the following industries is most likely to be affected adversely by this action? Heavy industries such as steel Utilities Cyclical industries Defensive industries

B

Due to unfavorable business conditions, a corporation whose common and preferred stock are traded on the New York Stock Exchange is forced to seek protection from its creditors. Who of the following is most likely to receive back the largest portion of their investment in the company's securities? Holders of the largest block of stock in the company The bankruptcy lawyers Holders of bonds collateralized by a mortgage on the company's real property Senior management of the company

C. Seeking protection from creditors is a nice way to say "filing for bankruptcy." Sure, the lawyers will get their money, but they aren't investors in the company, so they don't count in this question. Holders of secured debt, such as a mortgage bond, are in the senior position and generally will receive a return of a substantial portion (if not all) of their investment.

Which of the following statements regarding investment risk is not correct? Investors expect to earn a higher rate of return for assuming a higher level of risk. A stock's level of risk is a combination of market risk and diversifiable risk. Systematic risk may be reduced or eliminated by effective portfolio diversification. The beta coefficient measures an individual stock's relative volatility to the market.

C. Systematic risk, aka market risk, cannot be diversified!

When a corporation is forced to liquidate its assets, holders of which of the following securities are treated as general creditors? Subordinated debentures Mortgage bonds Debentures Senior lien preferred stock

C. The liquidation priority begins with secured debt, such as mortgage bonds. If there is anything left after meeting those claims, the next level is the general creditors. Debentures, because they are issued based on the "general credit standing of the issuer," are in that pool. Below them is the subordinated debt; that is the lowest of the debt claims. No matter how many adjectives you add to preferred stock, as an equity security, it has priority only ahead of common stock.