IAR Risk Assessment & Management 2 — Questions and Answers
Question 1: A client has a portfolio with a beta of 1.4. If the market declines by 10%, what is the expected portfolio decline?
- 10%
- 14% (Correct answer)
- 4%
- 1.4%
Correct answer: 14%
Beta measures systematic risk; a beta of 1.4 means the portfolio is expected to move 1.4 times the market, so a 10% market decline implies a 14% portfolio decline.
Question 2: Which of the following best describes 'liquidity risk' in the context of investment management?
- The risk that interest rates will rise unexpectedly
- The risk that an asset cannot be sold quickly without a significant price concession (Correct answer)
- The risk that a bond issuer will default on payments
- The risk that inflation will erode purchasing power
Correct answer: The risk that an asset cannot be sold quickly without a significant price concession
Liquidity risk is the danger that an investor cannot exit a position at a fair price due to insufficient market activity or depth.
Question 3: An IAR is reviewing a 70-year-old client's portfolio heavily weighted in small-cap growth stocks. The primary risk concern is:
- Reinvestment risk
- Currency risk
- Time horizon and volatility risk (Correct answer)
- Regulatory risk
Correct answer: Time horizon and volatility risk
A 70-year-old typically has a short time horizon, making high-volatility small-cap stocks inappropriate because there is limited time to recover from significant losses.
Question 4: Standard deviation is used in portfolio analysis primarily to measure:
- The correlation between two securities
- The total variability of returns around the mean (Correct answer)
- The portfolio's sensitivity to market movements
- The probability of issuer default
Correct answer: The total variability of returns around the mean
Standard deviation quantifies how much a portfolio's returns deviate from its average return, serving as a measure of total risk.
Question 5: A client is concerned about sequence-of-returns risk. This risk is most relevant for clients who are:
- In the accumulation phase with a 30-year horizon
- Beginning to draw down their portfolio in retirement (Correct answer)
- Investing exclusively in Treasury securities
- Diversified across multiple asset classes
Correct answer: Beginning to draw down their portfolio in retirement
Sequence-of-returns risk is the danger that poor early returns during the withdrawal phase can permanently deplete a portfolio before recovery can occur.
Question 6: Which risk management technique involves allocating a fixed percentage of a portfolio to different asset classes and periodically restoring those percentages?
- Dollar-cost averaging
- Rebalancing (Correct answer)
- Hedging
- Diversification
Correct answer: Rebalancing
Rebalancing restores a portfolio to its target asset allocation by selling appreciated assets and buying underperforming ones.
Question 7: A client asks about the Sharpe Ratio. An IAR should explain that it measures:
- Return per unit of systematic risk
- Excess return per unit of total risk (standard deviation) (Correct answer)
- The portfolio's correlation to a benchmark
- Downside deviation relative to a target return
Correct answer: Excess return per unit of total risk (standard deviation)
The Sharpe Ratio divides a portfolio's excess return (above the risk-free rate) by its standard deviation to indicate reward per unit of total risk.
IAR Risk Assessment & Management 2
A client has a portfolio with a beta of 1.4.
If the market declines by 10%, what is the expected portfolio decline?