Unit 11

Which of the following portfolios would most likely be exposed to the most inflation risk? A)34% diversified common stocks; 33% long-term convertible debentures; 33% non-cumulative preferred stock B)50% U.S. Treasury bonds, average maturity 20 years; 30% U.S. Treasury notes, average maturity 5 years; 20% 90-day Treasury bills C)100% employer's company stock D)75% S&P 500 index ETF; 25% municipal bond UIT

B)50% U.S. Treasury bonds, average maturity 20 years; 30% U.S. Treasury notes, average maturity 5 years; 20% 90-day Treasury bills Inflation risk is the bane of fixed income securities, especially those with longer maturities. On the other hand, as the percentage of common stock (or securities convertible into common stock) increases, the greater the inflation protection. Although placing all of one's portfolio into the employer's stock has enormous business risk, that doesn't answer this question.

n 1986, a sweeping change was made to the U.S. tax code. This change had a severe effect upon those who had been investing in certain limited partnership tax shelters. This is an example of A)business risk B)regulatory risk C)legislative risk D)market risk

C)legislative risk What happened here was a legislative change severely limiting expenses that could be deducted from income. Changes wrought by government action are legislative in nature.

Liquidity risk would be greatest for an investor whose portfolio was primarily composed of A)Nasdaq stocks B)municipal bond UITs C)municipal bonds D)ADRs listed on the NYSE

C)municipal bonds Any stock listed on the NYSE or traded on Nasdaq has high liquidity. Municipal bonds tend to be thinly traded, thereby exposing their holders to a higher degree of liquidity risk. UITs, regardless of their portfolio, stand ready to redeem their units so liquidity is not a problem for the investor.

A conservative investor decides to invest in high quality corporate bonds paying 5% instead of investing in lower quality bonds paying 9%. The additional 4% return the investor could have potentially earned on the lower quality bonds represents A)liquidity costs B)marketability costs C)opportunity cost D)purchasing power costs

C)opportunity cost Anytime an investor makes an investment, he is automatically precluded from investing that same money anywhere else. The potential additional earnings an investor might have earned from an alternative investment is known as opportunity cost.

The MNO Manufacturing Company, headquartered in Springfield, has just filed for bankruptcy. Under federal bankruptcy law, holders of which of the following would have highest priority with the bankruptcy trustee? A)Mortgage bonds B)First lien, senior preferred stock C)Guaranteed bonds D)Class A common stock

A)Mortgage bonds olders of a bond secured by mortgages on real property are senior creditors and have the highest priority claim in a bankruptcy. Guaranteed bonds have their principal (and interest) guaranteed by a party other than the issuer. The guarantee is only as strong as the guarantor and, because there is no collateral securing the obligation, these are in the category of general creditors. No matter how many adjectives are placed ahead of preferred stock, it always comes after everyone else who is owed money. Common stock, regardless of "class," is always the last in line.

From first to last, in what order would claimants receive payment in the event of bankruptcy? A)Secured debt, subordinated debentures, general creditors, preferred stockholders B)Subordinated debentures, preferred stockholders, general creditors, secured debt C)Preferred stockholders, secured debt, general creditors, subordinated debentures D)Secured debt, general creditors, subordinated debentures, preferred stockholders

D)Secured debt, general creditors, subordinated debentures, preferred stockholders The liquidation order is as follows: secured debt holders, unsecured debt holders (including general creditors), holders of subordinated debt, preferred stockholders, and common stockholders.

Which of the following will be the most likely risk that you will face during the first year after purchasing a corporate AA bond that matures in 15 years? A)Market B)Interest rate C)Inflation D)Liquidity

B)Interest rate With 15 years to maturity, even an investment-grade bond is subject to interest rate risk. This is particularly true during the early years because price fluctuations are greater when duration is longer. Inflation risk is not very great over a period of only 1 year, and AA bonds generally possess better-than-average liquidity. For this exam, market risk usually applies to equity securities rather than debt.

If your client is primarily concerned about the rising cost of living but wishes to limit his exposure to business risk, which of the following securities is most appropriate? A)Tax-free municipal bond B)S&P 500 index fund C)Small-cap stock fund D)AAA intermediate-term corporate bond

B)S&P 500 index fund S&P index funds are growth-oriented investment vehicles that have traditionally outpaced inflation and, because of their diversification, tend to limit business risk. Small-cap stock funds should also outpace inflation but carry too much risk for a client who wishes to limit business risk. Bonds, whether corporate or municipal, as fixed income investments, are generally not suitable for clients whose primary concern is protecting themselves against the rising cost of living.

The business school of a local university is conducting a symposium on investment risk. An IAR attending the session dealing with systematic risk would expect to learn about A)financial risk B)market risk C)regulatory risk D)business risk

B)market risk Systematic (nondiversifiable) risks are those which tend to impact the securities market as a whole. It is generally thought of as market risk although there are other examples of systematic risk, such as inflation risk. The other choices are unsystematic risks because they can be mitigated through portfolio diversification

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 A)purchasing power risk B)opportunity cost C)market cost D)duration risk

B)opportunity cost When an investor forgoes the risk-free returns of the 91-day Treasury bill in favor of another investment, anything lost is considered the opportunity cost of passing up the sure thing.