IFC Risk Management 2 — Questions and Answers
Question 1: A mutual fund manager wants to reduce the impact of a single stock's poor performance on the overall portfolio. Which risk management technique best addresses this concern?
- Concentration
- Diversification (Correct answer)
- Leverage
- Short selling
Correct answer: Diversification
Diversification spreads investments across multiple securities, reducing the impact of any single holding's poor performance on the overall portfolio.
Question 2: Which type of risk refers to the possibility that a fund cannot meet redemption requests without selling assets at unfavorable prices?
- Credit risk
- Market risk
- Liquidity risk (Correct answer)
- Inflation risk
Correct answer: Liquidity risk
Liquidity risk is the danger that a fund cannot quickly convert assets to cash at fair market value to meet investor redemption demands.
Question 3: An investment fund holds bonds from a corporation that subsequently declares bankruptcy. Which type of risk has materialized?
- Interest rate risk
- Credit risk (Correct answer)
- Currency risk
- Reinvestment risk
Correct answer: Credit risk
Credit risk (default risk) is the possibility that a bond issuer will fail to make promised interest or principal payments, as occurs in bankruptcy.
Question 4: When interest rates rise, what generally happens to the value of existing fixed-income securities in a fund?
- They increase in value
- They decrease in value (Correct answer)
- They remain unchanged
- They become more liquid
Correct answer: They decrease in value
Bond prices have an inverse relationship with interest rates; when rates rise, existing bonds with lower coupon rates become less attractive, causing their prices to fall.
Question 5: A Canadian mutual fund invests in US equities. If the Canadian dollar strengthens against the US dollar, what is the likely impact on the fund's returns for Canadian investors?
- Returns increase
- Returns decrease (Correct answer)
- Returns are unaffected
- Returns become more volatile
Correct answer: Returns decrease
When the Canadian dollar strengthens, US-denominated returns are worth less when converted back to Canadian dollars, reducing the fund's overall returns for Canadian investors.
Question 6: Which risk management tool measures the maximum expected loss of a portfolio over a specific time period at a given confidence level?
- Standard deviation
- Beta coefficient
- Value at Risk (VaR) (Correct answer)
- Sharpe ratio
Correct answer: Value at Risk (VaR)
Value at Risk (VaR) quantifies the maximum potential loss in portfolio value over a defined period with a specified statistical confidence level (e.g., 95% or 99%).
Question 7: A fund manager uses futures contracts to offset potential losses in the equity portfolio. This strategy is best described as:
- Speculation
- Arbitrage
- Hedging (Correct answer)
- Leverage
Correct answer: Hedging
Hedging involves using derivatives like futures to take an offsetting position that reduces the risk of adverse price movements in the existing portfolio.
IFC Risk Management 2
A mutual fund manager wants to reduce the impact of a single stock's poor performance on the overall portfolio.
Which risk management technique best addresses this concern?