IAR Risk Assessment & Management 5 — Questions and Answers
Question 1: Which of the following best describes 'political risk' as it pertains to international investments?
- The risk that domestic tax policy will change
- The risk that government actions in a foreign country will adversely affect investment values (Correct answer)
- The risk of rising domestic interest rates
- The risk that portfolio managers will make poor decisions
Correct answer: The risk that government actions in a foreign country will adversely affect investment values
Political risk refers to the possibility that foreign government actions — such as nationalization, currency controls, or regulatory changes — will negatively impact an investor's returns.
Question 2: A client is 45 years old with a 20-year investment horizon. According to modern portfolio theory, which of the following is most appropriate for this time horizon?
- A portfolio of only money market funds to avoid any volatility
- A diversified portfolio tilted toward equities to pursue long-term growth (Correct answer)
- 100% allocation to long-term government bonds
- A portfolio with no international exposure
Correct answer: A diversified portfolio tilted toward equities to pursue long-term growth
With a 20-year horizon, the client can weather short-term volatility, making a diversified equity-tilted portfolio appropriate to build wealth over time.
Question 3: The term 'risk-adjusted return' is most closely associated with which concept?
- Comparing raw returns among different investments without regard to risk
- Evaluating investment performance relative to the amount of risk taken to achieve that return (Correct answer)
- Adjusting returns for tax liability only
- Measuring performance against a benchmark index
Correct answer: Evaluating investment performance relative to the amount of risk taken to achieve that return
Risk-adjusted return measures how much return was earned per unit of risk, allowing fair comparison between investments with different risk profiles.
Question 4: A client requests that the IAR move all assets to cash because they fear a market correction. The IAR's best response in the context of risk management is to:
- Immediately liquidate all positions to satisfy the client
- Discuss the client's concerns, review the IPS, and explain the risks of market-timing including inflation and reinvestment risk (Correct answer)
- Refuse to discuss the matter until the market corrects
- Invest in the highest-yielding cash equivalent available
Correct answer: Discuss the client's concerns, review the IPS, and explain the risks of market-timing including inflation and reinvestment risk
An IAR acting as a fiduciary must engage the client in a dialogue about the risks of market-timing, reference the agreed-upon IPS, and ensure any changes are in the client's best long-term interest.
Question 5: Systematic risk is also known as:
- Idiosyncratic risk
- Diversifiable risk
- Market or non-diversifiable risk (Correct answer)
- Business risk
Correct answer: Market or non-diversifiable risk
Systematic risk is the risk inherent to the entire market (e.g., recessions, interest rate changes) and cannot be eliminated through diversification, hence it is called non-diversifiable risk.
Question 6: An IAR is constructing a portfolio for a client with a low risk tolerance. Which metric would best confirm the portfolio's downside risk profile?
- Treynor Ratio
- Sharpe Ratio
- Maximum drawdown (Correct answer)
- P/E ratio
Correct answer: Maximum drawdown
Maximum drawdown measures the largest peak-to-trough decline in portfolio value, giving a clear picture of the worst historical downside experience — most relevant for low-risk-tolerance clients.
Question 7: A client in the top federal tax bracket is concerned about after-tax returns. Which risk management strategy directly addresses this concern?
- Concentrating in high-dividend stocks
- Utilizing tax-loss harvesting to offset capital gains (Correct answer)
- Increasing turnover in the portfolio
- Avoiding all municipal bonds
Correct answer: Utilizing tax-loss harvesting to offset capital gains
Tax-loss harvesting realizes losses to offset capital gains, directly reducing tax drag on the portfolio and improving after-tax risk-adjusted returns.
IAR Risk Assessment & Management 5
Which of the following best describes 'political risk' as it pertains to international investments?