Foundation of Risk Quiz

For an investor to move further up the capital market line than the market portfolio, the investor must:

• continue to invest only in common stocks.

• diversify the portfolio even more.

• reduce the portfolio's risk below that of the market.

• borrow and invest in the market portfolio.

Which of the following statements about systematic and unsystematic risk is least accurate?

• As compared to a less-diversified portfolio, a diversified portfolio has lower unsystematic risk.

• The unsystematic risk for a specific firm is similar to the unsystematic risk for other firms in the same industry.

• As an investor increases the number of stocks in a portfolio, the systematic risk will remain constant.

• Total risk equals market risk plus firm-specific risk.

Abe Osbourne is a risk analyst who is evaluating the advantages and disadvantages of hedging risk exposures. Which of the following statements does not reflect an advantage of hedging?

• Hedging may allow management to control its financial performance to meet the requirements of the board of directors.

• Hedging through the use of derivatives instruments such as swaps and options may be cheaper than purchasing an insurance policy.

• Hedging will increase a firm’s long-term earnings and cash flows.

• Hedging may result in operational improvements within a firm.

According to capital market theory, which of the following represents the risky portfolio that should be held by all investors who desire to hold risky assets?

• Any point on the efficient frontier and to the right of the point of tangency between the CML and the efficient frontier.

• Any point on the efficient frontier and to the left of the point of tangency between the CML and the efficient frontier

• any point on the efficient frontier and above the CML.,

• The point of tangency between the capital market line (CML) and the efficient frontier

The creation of collateralized debt obligations (CDOs) most likely involves:

• forming an undiversified portfolio from a small sample of debt securities.

• the CDO issuer retaining the most senior tranches to give that bank incentive to monitor the loan.

• slicing the cash flows from a portfolio of collected debt securities into a number of investable tranches.

• selling the equity tranche to institutions that desire or require instruments with high credit ratings.

According to capital market theory, which of the following is the only efficient portfolio of risky assets investors should hold?

• The minimum variance portfolio on the efficient frontier

• The market portfolio at the point of tangency with the CML

• Any diversified portfolio on the efficient frontier

• A portfolio combining only individual securities with the highest Sharpe ratios

According to modern portfolio theory, which statement about portfolios below the CML is most accurate?

• They are superior because they minimize total risk

• They offer better returns for a given level of risk

• They are inefficient and suboptimal

• They consist only of risk-free assets

The tangency point between the CML and the efficient frontier represents:

• A) The global minimum variance portfolio
  

• B) A portfolio with unsystematic risk only
  

• C) The optimal risky portfolio — the market portfolio
  

• D) A portfolio dominated by the risk-free asset

Which of the following best describes a Collateralized Debt Obligation (CDO)?

• A financial contract providing insurance against interest rate movements
• A structured credit product made up of a pool of debt instruments divided into tranches
• A single bond issued by a corporation with embedded call options
• A swap used to hedge currency risk on a fixed-income portfolio

The tranching structure in a CDO primarily serves to:

• Increase the overall return of the pool
• Allow investors to select exposure based on risk tolerance
• Reduce the need for collateral in lending agreements
• Avoid the need for credit ratings