Series 66 Chapter 11
Your client purchases 100 shares of XYZ Electric Auto Company on the assumption that rising fuel costs will create more interest in this more efficient means of transportation. If he is wrong, the resulting drop in the market price of that stock would be due to A) market risk B) money-rate risk C) purchasing power risk D) business risk
D
A country decides to nationalize its sugar industry. This is an example of A) sovereign risk. B) political risk. C) business risk. D) financial risk.
B
You have been following GEMCO stock for the past couple of months and notice a recent increase in the stock's volatility. In the past month, several negative reports have been published about GEMCO's product line. This has caused a drop in the market price of the stock even though the GEMCO has just reported earnings that exceeded analyst's projections. This is an example of A) financial risk B) market risk C) purchasing power risk D) volatility risk
B
If you had expectations of high inflation, you would A) increase fixed-income exposure and reduce equity exposure B) increase fixed-income exposure and reduce commodity exposure C) increase equity exposure and reduce fixed income exposure D) increase fixed-income exposure and reduce tangible asset exposure
C
Inflation causes people living on a fixed income to have A) reduced systematic risk. B) fewer financial problems. C) declining purchasing power. D) unlimited resources.
C
One of the risks found in equity investing is known as unsystematic risk. The most common way to reduce this risk is? A) Specialization B) Increasing the positive correlation C) Diversification D) Reducing the beta coefficient
C
Prior to the opening of the securities markets, KAPCO Chemical Corporation reports quarterly earnings per share of $1.50, exceeding analysts' estimates by more than 10%. By the end of the trading session, KAPCO's stock price has fallen by 5%. This would be an example of A) regulatory risk B) financial risk C) market risk D) opportunity cost
C
The major risk for highly rated corporate bonds is A) stock market volatility B) tax law changes C) interest rate changes D) liquidity
C
When deciding on the suitability of a particular investment, that client's need for liquidity is A) only significant if the individual is planning on retirement B) only important if the client has no other liquid investments C) an important consideration when determining the suitability of an investment D) not a significant consideration
C
Which of the following is the risk that diminishes through portfolio diversification? A) Systematic risk B) Purchasing power risk C) Unsystematic risk D) Interest rate risk
C
Which of the following are considered unsystematic risks? Business Liquidity Market Purchasing power
1, 2
A general risk component representing the variability of a stock's total return as it directly relates to overall movements in the general economy is known as A) systematic risk. B) business risk. C) financial risk. D) political risk.
A
A stock that does not have a ready market is said to have a higher than average degree of A) liquidity risk B) business risk C) market risk D) investment risk
A
An investor has a majority of his portfolio in an ETF that mirrors the S&P 500. If the investor decided to liquidate that position and reinvest the proceeds into a single NYSE-listed common stock, it would most likely lead to an increase to the investor's A) business risk B) purchasing power risk C) interest rate risk D) liquidity risk
A
An investor is analyzing the impact of the specific type of risk affecting bonds because the fixed cash payments that they deliver may become less valuable. What risk is this? A) Inflation risk B) Interest rate risk C) Credit risk D) Systematic risk
A
Which of the following statements regarding risk diversification is least accurate? A) Diversification can successfully remove all portfolio risk. B) There is a tradeoff between risk and return. C) Unsystematic risk is company-specific risk that is particular to an individual company. D) Systematic risk or market risk results from unexpected changes in economic factors
A
A retired woman whose sole income comes from a portfolio of investments with a fixed rate of return is most affected by A) high inflation B) bearish market conditions C) volatile interest rates D) high income taxes
A Portfolios of fixed-income securities are most affected by inflation or rising prices. Rising prices or inflation is known as purchasing power risk. Because the portfolio has a fixed rate of return, interest rate changes will not affect the income received, but that income will have lost some of its purchasing power as a result of rising prices. Tax rates and market conditions would be of lesser importance to this investor.
A company using debt obligations to finance business expansion is indicative of what type of investment risk? A) Market risk B) Purchasing power risk C) Reinvestment rate risk D) Credit or default risk
D
The common stock of the YXZ Pharmaceutical Corporation, listed on the NYSE, is likely to be subject to business risk credit risk liquidity risk regulatory risk
1, 4
One of your firm's portfolio managers is discussing risk that can be reduced during the portfolio construction process. Which of the following options might she be referring to? A) Credit risk B) Unsystematic risk C) Market risk D) Systematic risk
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? A) Cyclical industries B) Utilities C) Heavy industries such as steel D) Defensive industries
B
The issuer-specific component of the variability in a stock's total return that is unrelated to overall market variability is known as A) systematic risk. B) unsystematic risk. C) nondiversifiable risk. D) fundamental risk.
B
Which of the following is a risk common to all fixed-income securities? A) Liquidity risk B) Interest rate risk C) Market risk D) Opportunity cost
B
Which of the following statements best defines inflation risk? A) The uncertainty that a given amount invested today in a fixed income instrument will not generate the same nominal income in the future B) The uncertainty that the value of an investor's assets will decrease as measured by real dollar purchasing power C) The uncertainty that one will not receive back an equal amount of principal in the future D) The uncertainty that the nominal return of an investment will not outpace the overall market
B Inflation risk is the uncertainty that an investment's purchasing power will decrease due to the shrinking value of the currency. An investor's real rate of return is the nominal rate less the inflation rate.
An investor buys a promising common stock expecting a return of 10%, while a 6% return is available in risk-free Treasury bills. In actuality, the common stock only returns 3%. By giving up the risk-free return to speculate on the stock, the investor has encountered A) spread B) interest expense C) opportunity cost D) yield curve
C
The STU Corporation has issued common stock, preferred stock, promissory notes, and mortgage bonds. Should STU enter bankruptcy proceedings, the order of payment against claims would be A) the mortgage bonds, the preferred stock the common stock, and the promissory notes. B) the preferred stock, the common stock, the mortgage bonds, and the promissory notes. C) the mortgage bonds, the promissory notes, the preferred stock, and the common stock. D) the promissory notes, the mortgage bonds, the preferred stock, and the common stock.
C
Each of the following would be considered a political risk except A) coups. B) nationalization of private industries. C) terrorism. D) adverse weather conditions.
D
If your client's entire investment portfolio consists of his company's employee stock ownership plan and stock in the company acquired under the executive stock option program, the client's portfolio is most exposed to A) interest rate risk B) market risk C) inflation risk D) business risk
D
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 A) market risk. B) business risk. C) country risk. D) regulatory risk.
D
U.S. Treasury bonds are generally subject to all of the following risks except A) purchasing power risk. B) reinvestment risk. C) inflation risk. D) liquidity risk.
D The market for U.S. Treasury bonds is highly liquid. As safe and as liquid as they are, they, like all fixed-income investments, are subject to purchasing power (also known as inflation) risk and reinvestment risk.
An investor originally purchased a debt security at par value. Unfortunately, the value has fallen to $920, even though the company has reported record earnings. This decline in value would be representative of what type of risk? A) Interest rate risk B) Purchasing power risk C) Credit risk D) Timing risk
A This decline in value is most likely due to interest rate risk, which indicates that as prevailing interest rates rise, the price of existing debt instruments declines. Purchasing power risk is essentially synonymous with inflation risk, and credit risk is the danger that the issuer may default on its debt service, something that seems unlikely considering the recent earnings reports.
A risk-averse client, living in the United States, holding a high proportion of his assets in cash and cash equivalents in U.S. dollars, is exposed to which of the following risks? A) Reinvestment rate risk B) Market risk C) Purchasing power risk D) Exchange rate risk
C
An investor's portfolio that consists of all long-term Treasury bonds is most vulnerable to which of the following types of risk? A) Business risk B) Marketability risk C) Interest rate risk D) Default (credit) risk
C
One of your clients owns shares of the NERP Corporation's senior preferred stock. He is concerned about NERP's financial solvency and wonders where he would fall in the event of NERP declaring bankruptcy. The proper response is, the client's claim is A) ahead of all claims because his stock has a senior claim. B) after the secured creditors, but ahead of the unsecured creditors because of the senior claim. C) after the creditors and the common stockholders. D) after the creditors, but ahead of the common stockholders.
D
Specific or unsystematic risk refers to investment risk that is A) due to fundamental risk factors B) due to the market measure of risk C) undiversifiable D) diversifiable
D
The potential for the market price of common stock in the ABC Corporation to fluctuate due to its tendency to move with all securities of the same type represents what kind of risk? A) Interest rate B) Inflation C) Business D) Market
D
What is most likely to happen to outstanding fixed-income securities when interest rates decline? A) Yields go up B) Coupon rates go up C) Prices go up D) No change
C
Among the advantages of being the holder of secured bond is that if the issuer files for bankruptcy, you A) will receive your principal plus all unpaid interest B) are paid ahead of everyone, except past-due wages to employees C) are sure to recover 100% of your investment D) are paid ahead of holders of unsecured debt, as well as equity securities
D
Which of the following statements regarding unsystematic risk are TRUE? It is the risk that an individual stock will not perform well. It is the same as market risk. Diversification reduces it. Diversification does not reduce it.
1, 3
Which of the following has the greatest liquidity risk? A) Long-term bond mutual fund B) Municipal bond unit investment trust (UIT) C) Real estate investment trust (REIT) D) Rental apartment building
D
In this industry, many words have similar meaning. Which of the following choices consists of a pair which are NOT properly considered synonyms? A) Interest rate risk—money rate risk B) Inflation risk—purchasing power risk C) Liquidity risk—marketability risk D) Financial risk—market risk
D
Which of the following are examples of systematic risk? Business risk Market risk Interest rate risk Credit (default) risk
2, 3
Which of the following describes unsystematic risk? A) It is related to market forces and cannot be diversified away. B) It is related to market forces and can be diversified away. C) It is specific to an investment and can be diversified away. D) It is specific to an investment and cannot be diversified away.
C
Which of the following is the risk that diminishes through portfolio diversification? A) Purchasing power risk B) Interest rate risk C) Unsystematic risk D) Systematic risk
C
An investment adviser is meeting with an elderly client whose portfolio consists largely of fixed-income investments. Over the past several years, she has been losing purchasing power. As a result, it would be important to inform her of A) liquidity risk B) market risk C) opportunity risk D) inflation risk
D
As interest rates rise, the opportunity cost of holding cash A) increases. B) decreases. C) remains the same. D) equals the risk-free rate.
A
Which of the following statements regarding the risks inherent in bonds is most accurate? A) Default risk deals with the likelihood that the issuer will fail to meet its obligation to pay interest and/or principal. B) The reinvestment rate assumption in calculating bond yields is generally not significant to the bond's yield. C) Price risk refers to the decrease in bond prices as interest rates fall. D) Interest rate risk is the risk that the bond's coupon rate will be adjusted downward if market rates decline.
A
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 A) liquidity risk B) market risk C) legislative risk D) interest rate risk
C
All of the following are examples of unsystematic risk EXCEPT A) political risk B) financial risk C) tenure risk D) purchasing power risk
D
Which of the following risks would be associated with long-term, AAA-rated bonds? A) Marketability B) Ability of the issuing company to pay interest and principal C) Unstable interest payments D) Purchasing power risk
D
Which 2 are most associated with a U. S. Treasury bond? Credit risk Liquidity risk Reinvestment risk Interest rate risk
3, 4 We negate credit risk when it comes to U.S. Treasury securities. Liquidity is also not an issue. However, any interest-bearing bond carries interest rate risk, as well as reinvestment risk.
An investor who is in search of greater return has a portfolio overconcentrated in speculative OTC Bulletin Board and OTC Link stocks. This investor's risk is best reduced through A) diversification B) reducing his time horizon C) hedging with broad-based put options D) arbitrage
A
The risk to bondholders that bonds may lose value during periods of increasing inflation is known as A) interest rate risk B) reinvestment risk C) marketability risk D) credit risk
A Interest rate risk is the risk that as interest rates rise, bond prices fall. Periods of inflation are accompanied by rising interest rates. Another risk in this scenario, but not an answer choice, is purchasing power risk; each semiannual interest payment has less purchasing power due to inflation, and, of course, the purchasing power of the principal at maturity will be far less as well.
Credit risk is commonly referred to as A) interest rate risk B) business risk C) unsystematic risk D) default risk
D
Which of the following industries is most exposed to regulatory risk? A) Publishing companies B) Consumer retailers C) Entertainment companies D) Public utilities
D
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 resulted in a $30 charge on your statement. Based on this exchange rate, each dollar was worth approximately A) $.33 B) 3 Zlotys C) $3.33 D) 3.33 Zlotys
D
If a business fails because a new technology makes its products obsolete, this is an example of A) interest rate risk B) inflation risk C) unsystematic risk D) systematic risk
C
If a customer is concerned about interest rate risk, which of the following securities is least appropriate? A) 10-year corporate bonds B) Treasury bills C) 25-year municipal bonds D) 5-year corporate bonds
C
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) business risk B) market risk C) legislative risk D) credit risk
C
Under modern portfolio theory, MPT, which of the following types of risk cannot be eliminated through diversification? A) Credit risk B) Business risk C) Systematic risk D) Liquidity risk
C
In October 1987, ABC Manufacturing Company showed a strong balance sheet. Nevertheless, its stock lost 15 points in the "crash of 1987." This is an example of A) business risk B) opportunity risk C) market risk D) beta
C Market risk is the risk that a specific stock's price will be driven by factors largely independent of its issuer. Business risk is unique to each business entity. Beta is a measure of a stock's volatility relative to the overall market. The question does not refer to the volatility or sensitivity of the stock to the overall market. Opportunity risk is not among the recognized sources of risk. Opportunity cost is a term in economics that refers to the return given up in order to invest in another instrument or project.
Steve and Haley, ages 48 and 45, respectively, invest in large-cap stocks, international stock mutual funds, and real estate. They consider themselves moderately aggressive investors. Their investment portfolio is subject to all of the following risks except A) default risk. B) systematic risk. C) business risk. D) currency risk.
A
Which of the following statements regarding investment risk is not correct? A) Investors expect to earn a higher rate of return for assuming a higher level of risk. B) The beta coefficient measures an individual stock's relative volatility to the market. C) Systematic risk may be reduced or eliminated by effective portfolio diversification. D) A stock's level of risk is a combination of market risk and diversifiable risk.
C
An agent for a well-known broker-dealer has taken it upon herself to look for investment opportunities for her clients. Her research indicates that, in spite of record earnings, the stock of GEMCO, Inc., is poised for a price reversal. Should this analysis prove correct, this would be an example of A) reinvestment risk B) regulatory risk C) financial risk D) market risk
D Market risk is the uncertainty that the market price of a stock will drop even when earnings are strong. Most stocks follow the "market" and this would appear to be no exception. Financial risk concerns itself with financing, particularly debt, so it is related to credit risk. Nothing in this question infers anything about financing difficulties.
A portfolio that is primarily invested in corporate bonds would be subject to credit risk interest rate risk opportunity cost purchasing power risk
1, 2, 3, 4 Unless the security is a U.S. government bond, all bonds have credit risk. Including government bonds, they all fluctuate with changes in the interest rates and lose value due to inflation. Opportunity cost is the risk taken by choosing to invest in a lower-risk investment rather than attempt the higher returns that historically have been earned though investment in equities.
Which of the following is an example of business risk? A) A company's earnings decline because of a change in technology. B) The value of the U.S. dollar declines, making imports more expensive. C) The Dow Jones Industrial Average falls sharply. D) Inflation increases at a greater rate than expected.
A
Despite superior stock price increases in the computer industry in a given year, the stock of ABC Computers loses 47%. Following the third losing quarter, if the chief financial officer is fired, this is an example of: A) business risk B) default (credit) risk C) market risk D) regulatory risk
A Business risk is a unique danger related to a specific business entity, and both the chief financial officer and the stock suffered risk unique to the corporation. Market risk refers to the general risk of investing in securities rather than to the operating risk of a company. Regulatory risk refers to the risk of decisions of a regulatory body adversely affecting an industry. Default risk refers to the ability of a corporation to meet its debt payments.
If interest rates are dropping, an investor with a maturing bond will be most concerned with A) a positive yield curve B) the quality declining with the yield C) the difficulty in finding another investment with a like yield D) a negative yield curve
C When interest rates decline, investors with maturing bonds will have to accept a lower return on their reinvested principal. This is often called reinvestment risk. Although zero-coupon bonds avoid this risk until maturity, once the bond matures, just like any other bond, the matured principal will have to be invested at current market yields.
Angela, a wealthy client of yours, has constructed her portfolio with individual common stocks that closely match the weighting of the S&P 500 index. In so doing, Angela has significantly reduced her A) systematic risk B) default risk C) market risk D) business risk
D By matching the composition of the S&P 500 index, the client has broadly diversified her portfolio. One of the primary benefits of diversification is the reduction of business risk, an unsystematic risk. Market risk, one of the systematic risks, is not reduced through diversification. Default (or credit) risk, would apply when the portfolio contains debt securities.
All of the following statements concerning the types of risk are correct except A) financial risk is the risk that a firm's financial structure will negatively affect the value of an equity investment. B) business risk is the uncertainty regarding operating income. C) default risk is the potential inability of a debt issuer to make timely interest and principal repayments. D) reinvestment rate risk is the risk that proceeds available for reinvestment must be reinvested at a higher rate than that of the investment vehicle that generated the proceeds.
D Reinvestment rate risk is the risk that proceeds available for reinvestment might be reinvested at a lower rate than that of the investment vehicle that generated the proceeds. The computation of a bond's yield to maturity assumes that the coupon interest will be reinvested at the coupon rate. Reinvestment risk is the uncertainty of that happening.
On October 15, 2008, the Dow Jones Industrial Average lost 733 points, the largest single point drop in its history. After the markets closed on Tuesday, October 14th, ABC Manufacturing Company released its 3rd quarter operating results with earnings that surpassed all estimates. However, by the close of the market on October 15th, the price of the stock was down 15 points. This is an example of A) business risk B) beta C) opportunity cost D) systematic risk
D Systematic risk (market risk) is the danger that a specific stock's price will be driven by factors largely independent of its issuer such as a severe market plunge. Business risk is unique to each business entity. Beta is a measure of a stock's volatility relative to the overall market. Opportunity cost refers to the return given up in order to invest in another instrument or project.
Which of the following statements are TRUE? Systematic risk can be diversified away. Systematic risk cannot be diversified away. Unsystematic risk can be diversified away. Unsystematic risk cannot be diversified away.
2, 3
Because of the decline in sales revenues, a company that had forecast an earnings growth of 25% now forecasts growth of only 12%. This is an example of what type of risk in the investment of securities? A) Business risk B) Market risk C) Purchasing power risk D) Interest rate risk
A
John purchased stock of a company in the business of manufacturing yachts. Two years ago his securities had lost most of their value as a result of a congressionally imposed luxury tax on purchases of more than $30,000. John's investment in the yacht-building business suffered a loss due to A) legislative risk B) regulatory risk C) business risk D) volatility
A
Which of the following statements pertaining to the types of risk is not correct? A) Exchange rate risk is the variability in returns on securities caused by currency fluctuations. B) Interest rate risk is the risk that the market price of an investment will decline as the result of changes in market interest rates. C) Reinvestment rate risk is the uncertainty that surrounds the rate of return that can be earned on reinvested coupon income. D) Business risk is the uncertainty of price fluctuations in the stock market.
D
Which of the following statements regarding investment risk is NOT correct? A) Systematic risk may be reduced or eliminated by effective portfolio diversification. B) Investors expect to earn a higher rate of return for assuming a higher level of risk. C) The beta coefficient measures an individual stock's relative volatility to the market. D) A stock's level of risk is a combination of market risk and diversifiable risk.
A
Which of the following securities are the most interest rate sensitive? Utility stocks Growth stocks Preferred stocks Common stocks
1, 3
Calvin has the following securities in his portfolio: ABC common stock, XYZ common stock, PQR mutual fund (domestic small cap), DEZ mutual fund (foreign small cap), 30-year Treasury bond, and 5-year Treasury note. Which of the following risks should not concern Calvin? A) Reinvestment rate risk B) Systematic risk C) Business risk D) Default risk
D Default risk applies only to debt securities. That is, one can default only on a debt (failure to pay the interest when due and/or the principal). For exam purposes, there is one category of debt securities that has no default risk: securities issued by the U.S. Treasury. Therefore, with a portfolio consisting of nothing but equity securities and Treasuries, default risk would not be a concern to Calvin. Business risk is the uncertainty that a corporation will underperform, either due to management failures or some other event unique to that company or industry. That is certainly a concern with the investments in ABC and XYZ common stock. To a lesser degree (because of the diversification), business risk also applies to ownership of mutual funds. Reinvestment rate risk is the risk that as cash flows are received they will be reinvested at lower rates of return than the investment that generated the cash flows and applies largely to any debt security. Systematic risk is the risk that all securities are subject to and typically cannot be eliminated through diversification.
