IAR Risk Assessment & Management 3 — Questions and Answers
Question 1: A client's investment policy statement (IPS) should document risk tolerance as:
- A verbal agreement between client and adviser
- A subjective estimate made solely by the adviser
- Both the client's willingness and ability to take risk (Correct answer)
- Only the client's emotional comfort with market fluctuations
Correct answer: Both the client's willingness and ability to take risk
A complete risk assessment captures both risk capacity (financial ability to absorb losses) and risk tolerance (emotional willingness to endure volatility).
Question 2: Which of the following is an example of unsystematic risk that can be reduced through diversification?
- Inflation risk
- Interest rate risk
- A product recall that harms a single company's stock (Correct answer)
- A global recession reducing all equity values
Correct answer: A product recall that harms a single company's stock
Unsystematic (idiosyncratic) risk is company- or industry-specific and can be reduced by holding a diversified portfolio; a product recall affects only the specific company.
Question 3: When using Monte Carlo simulation in financial planning, an IAR is primarily assessing:
- The exact future portfolio value
- The probability of achieving financial goals across many scenarios (Correct answer)
- The portfolio's correlation to GDP growth
- The tax efficiency of the portfolio
Correct answer: The probability of achieving financial goals across many scenarios
Monte Carlo simulation runs thousands of random scenarios to estimate the probability that a client's portfolio will meet its goals under various return and volatility assumptions.
Question 4: Duration is a key measure of risk for bond portfolios because it estimates:
- Credit quality of the bond issuer
- The bond's sensitivity to changes in interest rates (Correct answer)
- The likelihood of early call by the issuer
- Reinvestment rate assumptions over the bond's life
Correct answer: The bond's sensitivity to changes in interest rates
Duration measures how much a bond's price will change for a 1% change in interest rates; longer duration means greater interest rate sensitivity.
Question 5: A client insists on concentrating 80% of investable assets in a single employer's stock. The IAR's primary responsibility is to:
- Execute the order immediately since it is the client's right
- Document the risk, explain diversification benefits, and retain the client's signed acknowledgment (Correct answer)
- Refuse to manage the account
- Recommend the position only if the stock has low beta
Correct answer: Document the risk, explain diversification benefits, and retain the client's signed acknowledgment
IARs must act in the client's best interest by disclosing concentration risk and ensuring informed consent, while still respecting client autonomy.
Question 6: Correlation coefficients between assets range from -1 to +1. Which correlation provides the greatest diversification benefit?
- +1.0
- +0.5
- 0.0
- -1.0 (Correct answer)
Correct answer: -1.0
A correlation of -1.0 means two assets move in exactly opposite directions, providing the maximum diversification benefit and potential to eliminate combined portfolio volatility.
Question 7: An IAR recommends long-term care insurance to a client as part of a financial plan. This addresses which category of risk?
- Market risk
- Longevity and health care cost risk (Correct answer)
- Currency risk
- Reinvestment risk
Correct answer: Longevity and health care cost risk
Long-term care insurance transfers the financial risk of extended health care needs in old age, addressing longevity and health cost risk within a comprehensive financial plan.
IAR Risk Assessment & Management 3
A client's investment policy statement (IPS) should document risk tolerance as: