Asset Allocation & Risk Management Flashcards

A zero-cost collar on a stock position involves:

Answer: Buying a put and selling a call with offsetting premiums

The call premium received funds the protective put, capping both downside and upside.

Tail risk in asset allocation refers to:

Answer: Risk of extreme events in the distribution's far ends

Tail risk is the probability of extreme outcomes, often underestimated by normal distributions.

Fat-tailed (leptokurtic) return distributions imply that normal-distribution VaR will tend to:

Answer: Understate extreme losses

Fat tails mean extreme losses occur more often than a normal model predicts.

During financial crises, asset correlations typically:

Answer: Rise, reducing diversification benefits

Correlations tend to spike in crises, so diversification fails when it is needed most.

A goals-based allocation approach organizes a client's portfolio by:

Answer: Sub-portfolios tied to specific goals with distinct horizons and probabilities

Goals-based investing creates separate modules for each goal, sized to its required success probability.

Which factor is MOST likely to raise an individual's ability to take risk?

Answer: Substantial wealth relative to liabilities and a long horizon

Ample wealth relative to needs and a long horizon increase capacity to absorb losses.

Hedging foreign currency exposure in an international bond portfolio typically:

Answer: Reduces volatility because currency moves make up a large share of foreign bond risk

Currency volatility often exceeds local bond volatility, so hedging sharply lowers total risk.