Unit 13

Which fo the following statements about diversification are TRUE? I. Diversification involves investing portfolio in one, or very few, classes of investments II. Diversification is a way to reduce unsystematic risk in a portfolio. III. Diversification is a defensive investment strategy A. I and II B. II and III C. I and III D. I, II and III

B. Diversification is a defensive investment strategy of investing in several different classes of investments. it is designed to lower the unsystematic or business risk in a portfolio. The opposite of diversification, concentration, is an aggressive strategy of concentrating the portfolio in one, or very few, classes of investments.

The common stock of the YXZ Pharmaceutical Corporation, listed on the NYSE, is likely to be subject to: I. Business risk II. credit risk III. liquidity risk IV. regulatory risk A. I and II B. III and IV C. I and IV D. II and III

C. All common stock has business risk but no credit risk because there is no debt obligation involved. The Pharmaceutical Indus is one that is particularly subject to regulatory risk. As a general rule, we do not consider listed or Nasdq stock to have any great degree of liquidity risk.

Which of the following is a risk common to all fixed income securities? A. Opportunity cost B. Liquidity risk C. interest rate risk D. Market risk

C. One characteristic of all fixed income securities is that the income never changes (fixed) so when interest rates change, the income of those securities can't follow along. Therefore, one risk common to all fixed income securities is interest rate risk.

All of the following risks are considered diversifiable EXCEPT A. currency risk B. liquidity risk C. purchasing power risk D. 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.

You recently took a trip to Warsaw, Poland and when you received your credit card statement, you noticed that your vodka purchase for 100 Polish Zlotys resulting in a $30 charge on your statement base on this exchange rate, each dollar was worth approximately A. $3.33 B. 3 Zlotys C. 3.33 Zlotys D. $.33

C. When making investment (or a transaction) in a foreign currency, it is important to be able to translate that into the exchange rate for your home currency. to do so, we divide the purchase in the foreign currency by the charge in US dollars. In this case, 100 Zlotys only cost $30 so that makes each dollar worth 3.33 Zlotys

The uncertainty resulting from the possibility that the value of an investment will be affected by a change in the law is known as: A. credit risk B. business risk C. market risk D. legislative risk

D. The possibility that the value fo an investment will be affected by changes in government laws is known as legislative risk. Market risk is the risk that the value of an investment will decrease because of changes in the market price of the investment. Business risk is the uncertainty about the prospects of the company that issues the security, while credit risk involves the possibility that the issuing company will be unable to repay it's debt obligations.

True or False: The term risk refers to the uncertainty that an investment will rear less than its historical return

F. In finance, the term risk is defined as the uncertainty that an investment will ear its expected rate of return

True or False: Market risk (systematic risk) is the risk associated with the specific business decisions of a company's manager.

F. Market risk is systematic risk, or the risk that the overall market will have an adverse effect on a security independent of the company's circumstances.

True or False: Regulatory risk is the risk that the regulatory environment in which a company operates will change as a result of legislation.

F. Regulatory risk is the risk a company faces that the rules of the game will change as a result of new regulations, not legislation. Remember, regulations are written by government or other agencies while legislation is done by a political body, usually one that has been elected rather than appointed.

True or False: Standard deviation is a measure of inflationary pressures on the performance of a company.

F. Standard deviation is a measure of an investments' volatility. It measures the amount of variance in price or returns form the investment's mean return during an expected period.