SecurityUnit6

• D)
• Explanation

Treasury bonds are not at all susceptible to business risk; they are backed by the full faith and credit of the U.S. government. Corporate bonds are mostly subject to financial risk, and money markets are very low risk. Common stocks are most at risk from bad business decisions.

• A)
• Explanation

Legislative risk results from a change in the law. Changes to the tax code are the most common legislative risks. Regulatory risk comes from a change to regulations that might impact certain individuals or businesses. The imposition of environmental regulations is one such example.

• C)
• Explanation

One of the advantages of a security being traded on a U.S. listed stock exchange is the ready availability of buyers and sellers. This means the investment can be considered a liquid onejQuery112405265629715066142_1613430482549easy to divest of at a fair price, if and when one needs to.

A)

Explanation

Business risk is an operating risk related to poor or untimely management decisions. Decisions regarding if and when to introduce new products are one example of those that might expose investors specifically to business risk.

• D)
• Explanation

Whenever investing abroad, investors may be exposed to a number of risks that would not occur when investing in the U.S. domestic markets. Currency risk, for example, is the possibility that an investment denominated in one currency could decline if the value of that currency declines in its exchange rate with the U.S. dollar.

• B)
• Explanation

Inflation can generally be associated with diminished purchasing power??purchasing power risk. During times of inflation, a dollar will not be able to purchase what it had previously in the way of goods and services. Investments such as bonds paying fixed rates of return are negatively impacted during these times.

• D)
• Explanation

Capital risk is one of the nonsystematic risks that can be reduced by diversification. It represents the potential for loss due to circumstances unrelated to an issuer's financial strength. While it is considered minimal to none for U.S. government securities, it is generally high for derivative products, such as options.

• A)
• Explanation

The concept of reinvestment risk has to do with the ability to reinvest proceeds from one sale or redemption while still maintaining the same yield or return. This is difficult to do in times when interest rates are falling.

• A)
• Explanation

Sovereign risk is when a country is at risk of defaulting on its commercial debt obligations. When this occurs, the impact is felt on financial markets worldwide.

• C)
• Explanation

Systematic risk is the risk that changes in the overall economy will have an adverse effect on individual securities, regardless of the company's circumstances. Understanding what it is, is to know that no amount of diversification will eliminate it completely. While one might be able to mitigate it somewhat, one cannot diversify away systematic risk.

• D)
• Explanation

Stocks generally have had performance that outpaces inflation. Lower quality bonds with shorter maturities would pay a higher rate than government bonds and have the potential to keep up with inflation. Treasuries have very low yields and do not keep pace with inflation.

• D)
• Explanation

The two categories of investment risks are systematic (the risk that change in overall economy will impact individual securities) and nonsystematic (those risks that are unique to a particular industry, business, or investment type).

• A)
• Explanation

The inability to invest proceeds from an investment that had been earning a higher rate of return, at the now current lower rate, is known as reinvestment risk.

• B)
• Explanation

Whenever investing in securities issued in non-U.S. markets, investors need to be sensitive to the different risks that might apply to foreign investments. Of those listed here, currency risk should be of concern. Currency risk is the possibility that an investment denominated in a foreign currency could decline for U.S. investors if the value of that currency declines in its exchange rate with the U.S. dollar.

• D)
• Explanation

Sometimes referred to as purchasing power risk, inflation risk is the effect of rising prices over a long period while an investor is collecting fixed interest payments. For example, if a bond's yield is lower than the inflation rate, the purchasing power of the interest payments received diminishes over time.

• D)
• Explanation

While it can be noted that sovereign risk is a type of political risk, the risk of default by a country on its debt instruments is specifically recognized as sovereign risk.

C)

Explanation

When legislation is passed that affects the income received on an investment, the investor is exposed to legislative risk. Only a legislature can change tax rates.

• C)
• Explanation

Market risk is the risk that when the overall market declines, so too will any portfolio made of securities the market is composed of.

• C)
• Explanation

Bond prices move down when interest rates move up. Money market instruments can also be affected, but bonds are more impacted due to longer duration.

• A)
• Explanation

The enactment of, or changes in, laws represent potential legislative risk, whereas enactment of, or changes in, regulations represent regulatory risk. Political risk is specific to potential political instability associated more with emerging economies.

• C)
• Explanation

Bonds are more likely to be called when interest rates are falling. Call protection, a length of time during which the bond cannot be called, protects the investor during these times. Therefore, the call protection is least impactful when interest rates are rising??in other words, least impactful during times when the bond wouldn't likely be called.

• A)
• Explanation

Some callable bonds have a feature known as call protection, which essentially limits the issuer from calling them in before a certain date. The length of the call is predetermined, and during this time, the investor knows that the bind cannot be called away.

• A)
• Explanation

Call risk is the risk that a bond might be called before maturity. Often when this occurs, investors who receive their principal back sooner than anticipated are left to find ways to reinvest that will achieve the same returns??reinvestment risk.

• C)
• Explanation

By having a portfolio made up of only domestically listed U.S. securities, the investor is primarily avoiding political risk and currency risk. Political risk is attributable to political instability, rarely associated with U.S. domestic markets. Currency risk is most prevalent when buying or selling involves a foreign currency that can fluctuate in value against the U.S. dollar. While these two are avoided, the investor could still be exposed to each of the other risks listed here.

• C)
• Explanation

Interest-rate risk is one of the systematic risks that cannot be reduced by diversification. It is the risk that fluctuating interest rates will impact bond prices. Primarily, when interest rates are rising, bond prices will be pushed lower.

• C)
• Explanation

While political risk can be interrelated with legislative risk, most attribute this risk specifically to the potential instability in the political underpinnings of a country or economy. This risk is often associated with emerging economies, though it can potentially exist anywhere.

• B)
• Explanation

Safe investments tend to offer lower yields, but investments where considerable risk is attached should offer much higher potential yields. Higher yield is the potential reward for assuming greater risk.

• D)
• Explanation

While political risk, the potential instability in the political climate of a country or market, is mostly associated with emerging economies, it must be recognized that it can occur even in highly developed ones as well.

• A)
• Explanation

Systematic risk is the risk that changes in the overall economy will impact securities regardless of the company's business. Examples of that are inflation (purchasing power) risk, interest-rate risk, and market risk. Business risk and regulatory risk are examples of nonsystematic risk, the kind of risk that might be unique to certain businesses or industries.

• A)
• Explanation

Currency risk is the possibility that an investment denominated in one currency could decline if the value of that currency declines in its exchange rate with the U.S. dollar. Currency risk is an example of a "borderline" case on its classification as nonsystematic. From the view as a US investor (the default assumption for FINRA exams)currency risk may be mitigated by diversification between domestic and foreign stocks, as well as stocks of companies from different nations. For test purposes it is considered nonsystematic.

• A)
• Explanation

Systematic risk is the risk that changes in the overall economy will have an adverse effect on individual securities regardless of the company's circumstances. Common causes that can impact all securities or investments might be war, global security threats, and inflation.

• D)
• Explanation

Inflation, or continually rising prices, reduces the purchasing power that one's investment returns will have. This is the essence of inflation risk.

• D)
• Explanation

Call risk (the risk that when interest rates fall, issuers will call in existing callable debt) issues often leads to reinvestment risk for the investor. While receiving one's principal back sooner than expected, the investor is now left to reinvest at the now lower yield rates.

• B)
• Explanation

Changes in the overall regulatory climate or specific rule changes that impact an individual company's business model can have an effect on the company's performance or ability to operate profitably. Those holding the securities of such companies are exposed to regulatory risk.

• B)
• Explanation

Investments in stocks and bonds are considered fairly liquid, while investments in fixed assets like real estate, art or collectibles are not, and therefore relatively illiquid.

• B)
• Explanation

Having investments that are liquid means being able to divest of them quickly at a fair price. Liquidity risk comes for investors holding assets where doing that might not be possible.

• D)
• Explanation

This is interest-rate risk. When interest rates are rising, bond prices in the open market are pushed down. Rate movements and prices have an inverse relationship. Those already holding the bonds in their portfolios see their investments decrease in value. This also makes bonds trading in the open market less desirable because new issue bonds will be yielding the now higher rates and comparably be more desirable.

• D)
• Explanation

Nonsystematic risks can be reduced using diversification. These would include business, financial, credit, and liquidity risk (among others). Market, inflation, and interest-rate risks are types of systematic risks that are considered nondiversifiable because they impact all investments and, therefore, cannot be diversified away or mitigated simply by diversifying.

• A)
• Explanation

Particularly when taking aggressive positions, such as in options or DPPs, there is a greater likelihood that a substantial portion of the initial investment can be lost. This is best described as capital risk.

• A)
• Explanation

When prices are rising (inflation), purchasing power is reduced. During inflationary periods, a dollar today often doesn't purchase the quantity of goods and services it purchased yesterday.

• B)
• Explanation

Nonsystematic risks are those that are unique to a specific industry, business enterprise, or investment type.

• A)
• Explanation

Currency risk is due to the variations in exchange rate between countries and only impacts international investing.

• D)
• Explanation

Legislative risk results from changes in the law, not regulations. Changes in tax laws are one example.

• A)
• Explanation

Financial risk is the risk that an issuer would not be able to make principal and interest payments. This rules out government bonds and municipal general obligation bonds because they are backed by taxing power, and stocks don't pay principal and interest.

• A)
• Explanation

Purchasing power or inflation risk is a systematic risk. Capital risk, business risk, and call risk, among others, are nonsystematic risks, those that portfolio diversification can help to reduce.

• D)
• Explanation

Legislative risk is the risk that laws are introduced or amended. Always associate changes in tax laws or code with legislative risk.

• D)
• Explanation

Financial risk emanates from the use debt financing (leverage). It represents the potential inability to meet interest and principal payments on debt obligations, which can lead to bankruptcy. It is sometimes called credit risk or default risk.

• B)
• Explanation

Because all investments are different, carrying different levels of risk and reward, no investment can ever be assumed as being suitable for all investors. Each investment type and/or strategy will be suitable for some investors but not all.

• D)
• Explanation

If an investor has a purely domestic mutual fund portfolio considered to be as fully diversified as possible, expanding into funds investing in foreign securities is an obvious route to further diversification. The other risks and advantages listed are not peculiar to foreign businesses or securities.

• C)
• Explanation

When interest rates fall, issuers will call in their callable debt issues with the highest coupon rates first. These are the ones currently costing the issuer the most in interest payments. Therefore, when interest rates are falling, holders of higher coupon bonds are more exposed to call risk than are those investors holding lower coupon bonds.

• C)
• Explanation

Nonsystematic risks are those associated with the issuer (like a bad business strategy). Systematic risks impact large portions of the market and are difficult to reduce by diversification.

• A)
• Explanation

This is the definition of capital risk. For example, capital risk might be least when investing in securities backed by the federal government but much more prevalent when investing in derivative products.

• A)
• Explanation

Legislative risk occurs because of changes in the law.

• B)
• Explanation

When interest rates are declining, it is difficult to invest proceeds from redemptions or distributions and maintain the same level of income one had previously without increasing credit or market risks. This is reinvestment risk.

• B)
• Explanation

Systematic risk points to changes in the overall economy. It has an adverse effect on individual securities apart from the company's circumstances. It is generally caused by factors that affect all businesses, such as war, global security threats, or rampant inflation. Call risk is dependent on any call features associated with a given security, and net sales are an issue of a company's success. No matter how diversified a portfolio is, it remains subject to systematic risk. An investor cannot diversify systematic risk away.

• B)
• Explanation

Limited partnerships are generally illiquid; the other options are actively traded securities.

• A)
• Explanation

When interest rates fall, callable securities are likely to be called. While the investor may receive the redemption proceeds sooner than anticipated, it is often difficult to reinvest while maintaining the same level of return due to the lower interest-rate environment. This is why reinvestment risk and call risk can be viewed as being closely associated with each other.

• C)
• Explanation

Changes in the regulatory climate or specific rules that might impact how a company operates or its ability to do so profitably are recognized as regulatory risk.

• D)
• Explanation

Debt financing or utilizing debt leverage too much can lead to the inability to meet principal and interest payments on a company's debt obligations. This is the definition of financial risk.

• B)
• Explanation

GNMAs are mortgage back securities; if homeowners pay off their mortgages early, mortgage backed securities are subject to prepayment risk.

• D)
• Explanation

A foreign stock or bond issuer runs all the usual risks associated with business, finance, and investment, but currency risk is peculiar to foreign investments. If the foreign currency involved weakens against the dollar, dividends and interest paid by the foreign company will buy fewer dollars and thus be smaller as far as the American investor is concerned.