Portfolio Management MCQ - Portfolio Management Section 2

56 Which of the following best describes a financial risk?

Financial risk arises from the financial markets.

57 Which of the following is not an example of model risk?

A
Using the one-year risk-free rate to discount the face value of a one-year government bond.
B
Assuming the tails of a returns distribution are thin when they are, in fact, fat.
C
Using standard deviation to measure risk when the returns distribution is asymmetric.

The risk-free rate is generally the appropriate rate to use in discounting government bonds. Although government bonds are generally default free, their returns are certainly risky. Assuming a returns distribution has thin tails when it does not and assuming symmetry in an asymmetric distribution are both forms of model risk.

58 Which of the following is the risk that arises when it becomes difficult to sell a security in a highly stressed market?

Securities vary highly in how liquid they are. Those with low liquidity are those for which either the number of agents willing to invest or the amount of capital these agents are willing to invest is limited. When markets are stressed, these limited number of investors or small amount of capital dry up, leading to the inability to sell the security at any price the seller feels is reasonable. Systemic risk is the risk of failure of the entire financial system and a much broader risk than liquidity risk. Credit risk is the risk of loss caused by a counterparty’s or debtor’s failure to make a promised payment.

59 The risks that individuals face based on mortality create which of the following problems?

The uncertainty about death creates two risks: mortality risk and longevity risk. The mortality risk (risk of dying relatively young) is manifested by a termination of the income stream generated by the person. In contrast, longevity risk is the risk of outliving one’s financial resources.

60 Which of the following is most likely a risk driver from the perspective of an organization?

Risks (and risk drivers) arise from fundamental factors in macro economies and industries.