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Question 1 of 10
1. Question
Which of the following statements is true regarding Investment risk?
Correct
Investment risk
The 10 types of investment risk are business risk, credit risk, interest rate risk, purchasing power risk, liquidity risk, reinvestment risk, taxability risk, market risk, social/political risk, and currency exchange risk. When evaluating potential investments, each of these risks must be considered in order to determine the comprehensive level of risk of the investment. Without a comprehensive understanding of the risks of the investment, an investor or adviser cannot ensure that any investment recommendation is truly suitable.Incorrect
Investment risk
The 10 types of investment risk are business risk, credit risk, interest rate risk, purchasing power risk, liquidity risk, reinvestment risk, taxability risk, market risk, social/political risk, and currency exchange risk. When evaluating potential investments, each of these risks must be considered in order to determine the comprehensive level of risk of the investment. Without a comprehensive understanding of the risks of the investment, an investor or adviser cannot ensure that any investment recommendation is truly suitable. -
Question 2 of 10
2. Question
Which of the following statements is true regarding Business risk?
Correct
Business risk
Business risk is defined as the possibility that a company’s financial performance could have a negative impact on the returns to the company’s investors. Business risk can be influenced by a number of factors, including sales/revenue that don’t meet expectations, shrinking margins, or increased pressure from competitors.Incorrect
Business risk
Business risk is defined as the possibility that a company’s financial performance could have a negative impact on the returns to the company’s investors. Business risk can be influenced by a number of factors, including sales/revenue that don’t meet expectations, shrinking margins, or increased pressure from competitors. -
Question 3 of 10
3. Question
Which of the following statements is true regarding Credit risk?
Correct
Credit risk
Credit risk is defined as the possibility that a company may not live up to its contractual obligations. Credit risk is most commonly associated with fixed income investments as the company must provide for periodic coupon payments within fixed income investments and these coupon payments represent a large portion of the overall return provided. Typically, companies with financial difficulties who may not be able, or willing, to meet coupon payments must issue debt instruments with significantly higher coupon rates to compensate investors for taking that additional risk.Incorrect
Credit risk
Credit risk is defined as the possibility that a company may not live up to its contractual obligations. Credit risk is most commonly associated with fixed income investments as the company must provide for periodic coupon payments within fixed income investments and these coupon payments represent a large portion of the overall return provided. Typically, companies with financial difficulties who may not be able, or willing, to meet coupon payments must issue debt instruments with significantly higher coupon rates to compensate investors for taking that additional risk. -
Question 4 of 10
4. Question
Which of the following statements is true regarding Interest rate risk?
Correct
Interest rate risk
Interest rate risk is defined as the possibility that a change in market interest rates or in the term structure of interest rates or yield curve could have a negative impact on an investor’s returns. Like credit risk, interest rate risk is primarily associated with fixed income investments. As market interest rates rise, the price of a fixed income security will fall because the investor’s preference, at equal prices, would be to receive the security with the higher coupon rate.Incorrect
Interest rate risk
Interest rate risk is defined as the possibility that a change in market interest rates or in the term structure of interest rates or yield curve could have a negative impact on an investor’s returns. Like credit risk, interest rate risk is primarily associated with fixed income investments. As market interest rates rise, the price of a fixed income security will fall because the investor’s preference, at equal prices, would be to receive the security with the higher coupon rate. -
Question 5 of 10
5. Question
Which of the following statements is true regarding Purchasing power risk?
Correct
Purchasing power risk
Purchasing power risk is defined as the risk faced by investors that unexpected changes in inflation rates can negatively impact the return of an investment. Equity investors do not face much purchasing power risk because unexpected changes in inflation should result in an increase in dividend rates as well as appreciation of the stock’s price. However, once a fixed income investment is purchased, the payments they receive are fixed.Incorrect
Purchasing power risk
Purchasing power risk is defined as the risk faced by investors that unexpected changes in inflation rates can negatively impact the return of an investment. Equity investors do not face much purchasing power risk because unexpected changes in inflation should result in an increase in dividend rates as well as appreciation of the stock’s price. However, once a fixed income investment is purchased, the payments they receive are fixed. -
Question 6 of 10
6. Question
Which of the following statements is true regarding Liquidity risk?
Correct
Liquidity risk
Liquidity risk is defined as the possibility that the lack of liquidity within a security can have a negative impact for investors. One characteristic common to low liquidity is a wide spread between bid and ask prices. As investors who are forced to sell their positions receive lower prices due to the spread, those investors who are still holding their positions now see lower valuations. Liquidity risk is more relevant to equity investors than to fixed income investors, as fixed income investors are at least entitled to receive coupon payments and principal repayment at the scheduled maturity of the security.Incorrect
Liquidity risk
Liquidity risk is defined as the possibility that the lack of liquidity within a security can have a negative impact for investors. One characteristic common to low liquidity is a wide spread between bid and ask prices. As investors who are forced to sell their positions receive lower prices due to the spread, those investors who are still holding their positions now see lower valuations. Liquidity risk is more relevant to equity investors than to fixed income investors, as fixed income investors are at least entitled to receive coupon payments and principal repayment at the scheduled maturity of the security. -
Question 7 of 10
7. Question
Which of the following statements is true regarding Reinvestment risk?
Correct
Reinvestment risk
Reinvestment risk is defined as the possibility that investors who receive cash flows from securities will be forced to reinvest those cash flows into securities with lower interest rates or to accept additional risk in order to receive an equivalent rate. One example of reinvestment risk is an investor who purchases an 8% coupon, 20-year bond. Five years following the investment, the yield curve has flattened such that the long-end of the curve is now lower than it had previously been.Incorrect
Reinvestment risk
Reinvestment risk is defined as the possibility that investors who receive cash flows from securities will be forced to reinvest those cash flows into securities with lower interest rates or to accept additional risk in order to receive an equivalent rate. One example of reinvestment risk is an investor who purchases an 8% coupon, 20-year bond. Five years following the investment, the yield curve has flattened such that the long-end of the curve is now lower than it had previously been. -
Question 8 of 10
8. Question
Which of the following statements is true regarding Taxability risk?
Correct
Taxability risk
Taxability risk is defined as the possibility that an investment’s return will be negatively impacted because of a change in the tax treatment of the investment’s earnings. Returns on equity investments are impacted by prevailing tax rates on dividends and short- and long-term capital gains, while fixed income coupons may be taxable or may be tax-exempt, depending on the issuer. An equity investor could be subject to taxability risk if he purchased a small-cap growth security that he plans to hold for five years.Incorrect
Taxability risk
Taxability risk is defined as the possibility that an investment’s return will be negatively impacted because of a change in the tax treatment of the investment’s earnings. Returns on equity investments are impacted by prevailing tax rates on dividends and short- and long-term capital gains, while fixed income coupons may be taxable or may be tax-exempt, depending on the issuer. An equity investor could be subject to taxability risk if he purchased a small-cap growth security that he plans to hold for five years. -
Question 9 of 10
9. Question
Which of the following statements is true regarding Market risk?
Correct
Market risk
Market risk is defined as a source of non-diversifiable risk that would be expected to negatively impact the returns on all securities. Some examples of systemic or market risks include terrorist attacks, natural disasters, and bank runs. These risks cannot be controlled by the security’s issuing company and will impact all of their competitors. Equity securities were significantly impacted following the terrorist attacks on 9/11.Incorrect
Market risk
Market risk is defined as a source of non-diversifiable risk that would be expected to negatively impact the returns on all securities. Some examples of systemic or market risks include terrorist attacks, natural disasters, and bank runs. These risks cannot be controlled by the security’s issuing company and will impact all of their competitors. Equity securities were significantly impacted following the terrorist attacks on 9/11. -
Question 10 of 10
10. Question
Which of the following statements is true regarding Social/political risk?
Correct
Social/political risk
Social/political risk is defined as the possibility that changes in the governmental structure of a country or an unsettling of the political landscape could negatively impact the returns on both equity and fixed income investments. Typically, both equity and fixed income investments would be impacted similarly by social/political risk.Incorrect
Social/political risk
Social/political risk is defined as the possibility that changes in the governmental structure of a country or an unsettling of the political landscape could negatively impact the returns on both equity and fixed income investments. Typically, both equity and fixed income investments would be impacted similarly by social/political risk.