Managing Investment Risk - Unit 2
(119).webp "Managing Investment Risk - Unit 2 - Quiz")
This quiz based on CPFA - Unit 2
- 1.
Risk is
- A.
Deviation from desired outcome
- B.
Deviation from expected outcome
- C.
Both the above
- D.
None of the above
Correct Answer
A. Deviation from desired outcomeExplanation
The correct answer is "Deviation from desired outcome." Risk refers to the possibility of experiencing an outcome that is different from what is desired or intended. It involves the uncertainty and potential for deviation from the expected or desired results. Therefore, risk can be defined as the deviation from the desired outcome.Rate this question:
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- 2.
Total Risk
- A.
Systematic Risk + Unsystematic Risk
- B.
Systematic Risk - Unsystematic Risk
- C.
Both the above
- D.
None of the above
Correct Answer
A. Systematic Risk + Unsystematic RiskExplanation
The correct answer is "Systematic Risk + Unsystematic Risk". This is because the total risk of an investment or a portfolio is composed of two components: systematic risk and unsystematic risk. Systematic risk, also known as market risk, is the risk that is inherent in the overall market and cannot be diversified away. It is caused by factors such as economic conditions, interest rates, and political events. Unsystematic risk, on the other hand, is the risk that is specific to a particular company or industry and can be reduced through diversification. Therefore, the total risk is the sum of these two components.Rate this question:
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- 3.
Measure of total risk
- A.
Beta
- B.
Standard deviation
- C.
Variance
- D.
Sharpe Ratio
Correct Answer
B. Standard deviationExplanation
Standard deviation is a measure of total risk because it calculates the dispersion or variability of a set of data points from the mean. In the context of investments, it measures the volatility or fluctuation of returns. A higher standard deviation indicates a greater level of risk, as there is a wider range of potential outcomes. Therefore, standard deviation is commonly used to assess and compare the risk associated with different investment options or portfolios.Rate this question:
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- 4.
Measure of systematic risk is
- A.
Jensen ratio
- B.
Standard deviation
- C.
Variance
- D.
Beta
Correct Answer
D. BetaExplanation
Beta is a measure of systematic risk because it quantifies the sensitivity of a stock or portfolio's returns to the overall market's fluctuations. It measures the extent to which an asset's price moves in relation to the market. A beta value greater than 1 indicates that the asset is more volatile than the market, while a value less than 1 suggests lower volatility. Therefore, beta is widely used by investors to assess the risk associated with an investment and make informed decisions based on their risk tolerance.Rate this question:
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- 5.
A risk which impacts the entire market/universe is
- A.
Total Risk
- B.
Systematic risk
- C.
Unsystematic risk
- D.
None of the above
Correct Answer
B. Systematic riskExplanation
Systematic risk refers to the risk that affects the entire market or universe of investments. It is also known as market risk and cannot be diversified away by holding a diversified portfolio. This type of risk is caused by factors such as economic conditions, political events, interest rates, and market trends. Unlike unsystematic risk, which can be reduced through diversification, systematic risk affects all investments and cannot be eliminated. Therefore, the correct answer is systematic risk.Rate this question:
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- 6.
Change in Government policies is an example of
- A.
Total Risk
- B.
Systematic risk
- C.
Unsystematic risk
- D.
None of the above
Correct Answer
B. Systematic riskExplanation
Change in government policies can be considered as an example of systematic risk. Systematic risk refers to the risk that affects the entire market or a specific sector, rather than being specific to a particular company or investment. Government policies can have a significant impact on the overall economy and market conditions, leading to changes in interest rates, regulations, taxation, and other factors that can affect the performance of all investments in the market. Therefore, a change in government policies can be seen as a source of systematic risk that affects all market participants.Rate this question:
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- 7.
The risk that is unique to a firm or an industry:
- A.
Total Risk
- B.
Systematic risk
- C.
Unsystematic risk
- D.
None of the above
Correct Answer
C. Unsystematic riskExplanation
Unsystematic risk refers to the risk that is specific to a particular firm or industry and cannot be diversified away. It is also known as idiosyncratic risk. This type of risk is caused by factors such as management decisions, competition, labor strikes, and other company-specific events. Unlike systematic risk, which affects the entire market, unsystematic risk can be reduced through diversification. Therefore, the correct answer is unsystematic risk.Rate this question:
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- 8.
When interest rate rises for other similar bonds or in the economy, Bond price falls. This is example of
- A.
Credit Risk
- B.
Interest Risk
- C.
Re-investment risk
- D.
Default risk
Correct Answer
B. Interest RiskExplanation
When interest rates rise, the price of bonds falls because the fixed interest payments on existing bonds become less attractive compared to new bonds issued at higher interest rates. This is known as interest rate risk. As interest rates increase, the value of existing bonds decreases, causing a decline in bond prices. Therefore, the correct answer is Interest Risk.Rate this question:
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- 9.
When Interest rate falls
- A.
Bond prices rise
- B.
Bond prices fall
- C.
No change
- D.
Can either rise or fall
Correct Answer
A. Bond prices riseExplanation
When interest rates fall, bond prices rise. This is because when interest rates decrease, the fixed interest payments provided by existing bonds become more attractive compared to new bonds issued at lower rates. As a result, investors are willing to pay a higher price for existing bonds in order to secure the higher interest payments. Therefore, the demand for bonds increases, causing their prices to rise.Rate this question:
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- 10.
A bond maturing in 1 year is issued at Rs. 1000, coupon of 9% payable annually. If interest rate rises to 10%, new bond price will be
- A.
Rs. 99.09
- B.
Rs 990.9
- C.
Rs 1000
- D.
Rs 1100
Correct Answer
B. Rs 990.9Explanation
When interest rates rise, the price of existing bonds decreases. This is because the fixed coupon payment on the bond becomes less attractive compared to the higher interest rates available in the market. In this case, the bond is issued at Rs. 1000 with a coupon rate of 9%. If the interest rate rises to 10%, the new bond price will be lower than Rs. 1000. The correct answer, Rs. 990.9, reflects this decrease in bond price due to the rise in interest rates.Rate this question:
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- 11.
A bond (A) maturing in 1 year is issued at Rs. 1000, coupon of 9% payable annually. A bond (B) maturing in 5 year is issued at Rs. 1000, coupon of 9% payable annually. If interest rate rises to 10%, the following is true:
- A.
Price of Bond (A) will fall more than Price of Bond (B)
- B.
Price of Bond (A) will fall less than Price of Bond (B)
- C.
Price of Bond (A) will rise
- D.
Price of Bond (B) will rise
Correct Answer
B. Price of Bond (A) will fall less than Price of Bond (B)Explanation
When the interest rate rises, the price of a bond falls. This is because the bond's fixed coupon rate becomes less attractive compared to the higher market interest rate. Bond A has a shorter maturity period of 1 year, so its price is less sensitive to changes in interest rates compared to Bond B, which has a longer maturity period of 5 years. Therefore, when the interest rate rises, the price of Bond A will fall less than the price of Bond B.Rate this question:
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- 12.
One way to avoid interest rate risk is to:
- A.
Hold the debt investments till maturity
- B.
Buy Government Bonds
- C.
Both the above
- D.
None of the above
Correct Answer
A. Hold the debt investments till maturityExplanation
Holding the debt investments till maturity is a way to avoid interest rate risk because it allows the investor to receive the full principal amount at the end of the investment period, regardless of any fluctuations in interest rates during that time. By holding the investment till maturity, the investor can avoid selling the investment at a potentially lower price due to changes in interest rates. Buying government bonds can also be a way to mitigate interest rate risk, as these bonds are generally considered to be safer and more stable compared to other types of debt investments. Therefore, the correct answer is "Both the above."Rate this question:
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- 13.
Re-investment risk increases if:
- A.
Interest rates rises
- B.
Interest rates decreases
- C.
Interest rate has no affect on re-investment risk
- D.
None of the above
Correct Answer
B. Interest rates decreasesExplanation
When interest rates decrease, it means that any future investments or reinvestments will be made at a lower rate. This increases the risk because the investor will earn less on their reinvested funds compared to what they were earning before. Therefore, a decrease in interest rates raises the reinvestment risk.Rate this question:
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- 14.
In personal finances, one also has to consider re-investment risk when
- A.
The maturity of a fixed income instrument is higher than the time horizon of the investor.
- B.
The maturity of a fixed income instrument is lower than the time horizon of the investor.
- C.
Both the above
- D.
None of the above
Correct Answer
B. The maturity of a fixed income instrument is lower than the time horizon of the investor.Explanation
When the maturity of a fixed income instrument is lower than the time horizon of the investor, it means that the instrument will mature before the investor's desired investment period. This creates re-investment risk because the investor will have to find another investment opportunity with potentially different terms and returns. This risk arises from the uncertainty of finding a suitable reinvestment option that can match or exceed the returns of the original instrument.Rate this question:
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- 15.
Ramlal Associates has failed to pay its interest obligations to its FD investors. This is an example of:
- A.
Credit Risk
- B.
Interest Risk
- C.
Re-investment risk
- D.
Default risk
Correct Answer
D. Default riskExplanation
The given scenario of Ramlal Associates failing to pay its interest obligations to its FD investors indicates a situation of default risk. Default risk refers to the possibility that a borrower or issuer will be unable to fulfill their financial obligations, such as making interest payments or repaying principal amounts. In this case, Ramlal Associates' failure to pay its interest obligations suggests that they are defaulting on their financial commitments to the FD investors.Rate this question:
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- 16.
Higher Credit Rating
- A.
Low Default Risk
- B.
Higher Default Risk
- C.
Can be either low or high default risk
- D.
None of the above
Correct Answer
A. Low Default RiskExplanation
The correct answer is "Low Default Risk." This means that the entity being referred to has a lower likelihood of defaulting on its financial obligations. A low default risk indicates that the entity is considered to be more financially stable and reliable, making it a safer investment option.Rate this question:
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- 17.
Which of the following statements is false
- A.
Rating is given for an instrument and not a firm
- B.
Two different instruments issued by the same firm can have different ratings
- C.
The rating is constant during the life of the debt instrument
- D.
Although the rating is not a guarantee, it is a reasonably good indicator of the safety of the debt instrument
Correct Answer
C. The rating is constant during the life of the debt instrumentExplanation
The given statement is false because the rating of a debt instrument is not constant during its life. Ratings can change over time based on the financial performance and creditworthiness of the issuer. Factors such as changes in the firm's financial health, market conditions, and economic factors can lead to a change in the rating of the instrument. Therefore, the rating of a debt instrument is not fixed and can vary throughout its life.Rate this question:
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- 18.
Security having Lower Bid and Ask Spread is called
- A.
Liquid Security
- B.
Illiquid Security
- C.
Financial Security
- D.
Physical Assets
Correct Answer
A. Liquid SecurityExplanation
A security with a lower bid and ask spread is called a liquid security. This means that there is a smaller difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask). A liquid security is easier to buy and sell in the market, as there is a higher level of trading activity and a smaller spread indicates higher market liquidity. This makes it more attractive to investors as they can enter and exit positions more easily without significant price impact.Rate this question:
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- 19.
US Citizen invest $1000 in Indian Bank fixed Deposit @10% for 1 year when exchange rate was Rs. 45 for US$1, after a year, rupee depreciates, and exchange rate is Rs. 50 per US$. The US citizen made a
- A.
Loss in investment
- B.
Gain in investment
- C.
No loss or gain
- D.
Insufficient data
Correct Answer
A. Loss in investmentExplanation
The US citizen made a loss in investment because the rupee depreciated against the US dollar. When the US citizen initially invested $1000, they received Rs. 45,000 (1000 x 45). However, after a year, when they converted their investment back to US dollars, they received Rs. 50,000 (1000 x 50). This means they lost Rs. 5,000 (50,000 - 45,000) in the conversion process. Hence, they made a loss in their investment.Rate this question:
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- 20.
If Grocery bill is Rs. 10000 pm today, the inflation has been 5% for the year. The next year grocery bill could be
- A.
Rs. 10000 pm
- B.
Rs. 11000 pm
- C.
Rs. 9000 pm
- D.
Rs. 10500 pm
Correct Answer
D. Rs. 10500 pmExplanation
The correct answer is Rs. 10500 pm. This is because the inflation rate is 5%, which means that prices are expected to increase by 5% over the year. Therefore, the grocery bill for the next year would be 5% higher than the current bill of Rs. 10000, which is Rs. 10500.Rate this question:
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- 21.
Type of risk which arises due to change in regulation of a country
- A.
Business Risk
- B.
Event Risk
- C.
Regulatory Risk
- D.
Investment Manager Risk
Correct Answer
C. Regulatory RiskExplanation
Regulatory Risk refers to the type of risk that arises due to changes in regulations or laws of a country. These changes can impact businesses and industries, leading to potential financial losses or disruptions in operations. Regulatory Risk includes factors such as changes in tax policies, environmental regulations, trade policies, labor laws, and other government regulations that can affect the profitability and viability of businesses. It is important for companies to closely monitor and adapt to regulatory changes to mitigate the potential negative impacts on their operations and investments.Rate this question:
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- 22.
A measure of excess return over a benchmark
- A.
Beta
- B.
Jensen
- C.
Sharpe Ratio
- D.
Alpha
Correct Answer
D. AlpHaExplanation
Alpha is a measure of excess return over a benchmark. It indicates the ability of an investment to outperform or underperform the market. A positive alpha suggests that the investment has generated higher returns than expected based on its level of risk, while a negative alpha indicates underperformance. Alpha is often used by investors to evaluate the skill of a fund manager or to compare the performance of different investment strategies.Rate this question:
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- 23.
Emergence of substitute product, is an example of
- A.
Business Risk
- B.
Event Risk
- C.
Regulatory Risk
- D.
Investment Manager Risk
Correct Answer
A. Business RiskExplanation
The emergence of a substitute product poses a potential threat to a business's market position and profitability. This is because customers may choose to switch to the substitute product, leading to a decrease in demand for the business's offerings. As a result, the business may experience a decline in sales and revenue, which can negatively impact its financial performance. Therefore, the emergence of a substitute product is an example of business risk, as it directly affects the business's ability to generate profits.Rate this question:
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- 24.
Standard Deviation
- A.
Is the square root of Variance
- B.
A measure of total risk
- C.
Both the above
- D.
None of the above
Correct Answer
C. Both the aboveExplanation
The correct answer is "Both the above" because standard deviation is indeed the square root of variance. It is a statistical measure that indicates the extent to which data points in a distribution vary from the mean. Therefore, it is a measure of total risk as it provides information about the dispersion or spread of the data set.Rate this question:
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- 25.
A measure of the degree to which rates of return for two investment assets, move together over time relative to their individual mean returns is
- A.
Standard Deviation
- B.
Variance
- C.
Covariance
- D.
Any all the above
Correct Answer
C. CovarianceExplanation
Covariance is a statistical measure that quantifies the relationship between the returns of two investment assets. It shows how the returns of the assets move together relative to their individual mean returns. A positive covariance indicates that the assets tend to move in the same direction, while a negative covariance suggests they move in opposite directions. Covariance is used to assess the diversification benefits of combining different assets in a portfolio and is an important tool in risk management and asset allocation.Rate this question:
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- 26.
Rajesh has invested only in Government Bonds which matures in 2014. For his short term goals, what kind of risk does he face?
- A.
Investment Risk
- B.
Liquidity Risk
- C.
Regulatory Risk
- D.
Default Risk
Correct Answer
B. Liquidity RiskExplanation
Rajesh faces liquidity risk because government bonds typically have a fixed maturity date and cannot be easily converted into cash before that date. If Rajesh needs money for his short-term goals before the bonds mature in 2014, he may face difficulties in selling the bonds or accessing the funds, leading to liquidity risk.Rate this question:
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- 27.
Madhuri is a conservative investor and puts her money only in Fixed Deposits which she rolls over every year. In a falling interest rate scenario, which risk can be of most concern to her?
- A.
Re-investment Risk
- B.
Default Risk
- C.
Inflation Risk
- D.
Taxation Risk
Correct Answer
A. Re-investment RiskExplanation
In a falling interest rate scenario, Madhuri's concern would be re-investment risk. This risk refers to the possibility that when her fixed deposit matures, she may have to reinvest her money at a lower interest rate. This means that she may not be able to earn the same level of returns as before, potentially impacting her overall investment growth. As a conservative investor relying on fixed deposits, she would want to ensure that her reinvestment options provide a satisfactory return to meet her financial goals.Rate this question:
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- 28.
Standard Deviation of a security in a given period measures________.
- A.
The deviation of returns from the security from their mean value in the period
- B.
The range between lowest and highest return given by the security in the period
- C.
The deviation of return on security from market return in the period
- D.
The extent of lower return on security than the market in the period
Correct Answer
A. The deviation of returns from the security from their mean value in the periodExplanation
The standard deviation of a security in a given period measures the deviation of returns from the security from their mean value in the period. It quantifies the amount of variability or dispersion of the returns from the average return. A higher standard deviation indicates a greater level of risk or volatility associated with the security, while a lower standard deviation suggests a more stable or consistent performance.Rate this question:
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- 29.
For a portfolio of two securities to achieve diversification, the _________.
- A.
Correlation between the securities needs to be positive
- B.
Correlation between the securities needs to be zero
- C.
Correlation between the securities needs to be negative
- D.
Correlation coefficient between the securities needs to be 0.5
Correct Answer
C. Correlation between the securities needs to be negativeExplanation
When the correlation between two securities is negative, it means that their returns move in opposite directions. This is beneficial for diversification because when one security is performing poorly, the other security may be performing well, offsetting the losses. By having negatively correlated securities in a portfolio, the overall risk is reduced as the portfolio is less likely to experience large losses. Therefore, for a portfolio to achieve diversification, the correlation between the securities needs to be negative.Rate this question:
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- 30.
The co-variance between two securities is 42.53, while their individual standard deviations are 13.98 and 3.35, respectively. Calculate the correlation coefficient (r) of these securities.
- A.
0.22
- B.
0.82
- C.
0.91
- D.
1.10
Correct Answer
C. 0.91Explanation
The correlation coefficient (r) is a measure of the strength and direction of the linear relationship between two variables. It is calculated by dividing the covariance of the two variables by the product of their individual standard deviations. In this case, the covariance is given as 42.53, and the standard deviations are 13.98 and 3.35. By dividing the covariance by the product of the standard deviations, we get a correlation coefficient of 0.91.Rate this question:
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Mar 07, 2024Quiz Edited by
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Jun 04, 2012Quiz Created by
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