IFC Risk Management 3 — Questions and Answers
Question 1: Systematic risk in an investment portfolio refers to:
- Risk unique to a specific company
- Risk that can be eliminated through diversification
- Risk affecting the entire market that cannot be diversified away (Correct answer)
- Risk arising from poor fund management
Correct answer: Risk affecting the entire market that cannot be diversified away
Systematic (market) risk stems from economy-wide factors like recessions or interest rate changes and affects all securities; it cannot be eliminated through diversification.
Question 2: A fund's beta of 1.5 indicates that the fund is expected to:
- Generate 1.5% annual return
- Move 1.5 times the market's movement in the same direction (Correct answer)
- Underperform the market by 50%
- Have 1.5 times the credit risk of its benchmark
Correct answer: Move 1.5 times the market's movement in the same direction
A beta of 1.5 means the fund is expected to rise or fall 1.5% for every 1% move in the market, indicating higher volatility than the benchmark.
Question 3: Which of the following best describes unsystematic risk?
- Risk caused by macroeconomic events
- Company-specific risk that can be reduced through diversification (Correct answer)
- Risk measured by a fund's standard deviation
- Risk arising from changes in government policy
Correct answer: Company-specific risk that can be reduced through diversification
Unsystematic (idiosyncratic) risk is specific to individual companies or industries and can be significantly reduced by holding a diversified portfolio of securities.
Question 4: Inflation risk in a fixed-income fund primarily refers to the danger that:
- The fund's bond holdings will default
- Rising inflation will erode the purchasing power of fixed interest payments (Correct answer)
- Interest rates will fall and reduce coupon reinvestment returns
- Currency fluctuations will reduce bond returns
Correct answer: Rising inflation will erode the purchasing power of fixed interest payments
Inflation risk means that the real value of fixed interest payments declines when inflation rises, reducing the purchasing power of income generated by the fund.
Question 5: A fund manager uses asset allocation to manage risk by distributing investments among equities, bonds, and cash equivalents. This approach primarily manages:
- Credit risk only
- Liquidity risk only
- Overall portfolio risk through diversification across asset classes (Correct answer)
- Currency risk only
Correct answer: Overall portfolio risk through diversification across asset classes
Strategic asset allocation across different asset classes (equities, bonds, cash) reduces overall portfolio risk since different asset classes often respond differently to market conditions.
Question 6: Which document is required to disclose the risks associated with investing in a Canadian mutual fund to potential investors?
- Annual report
- Fund facts document (Correct answer)
- Statement of executive compensation
- Proxy circular
Correct answer: Fund facts document
The Fund Facts document is a mandatory, plain-language disclosure document that must be provided to investors, containing key risk information about a Canadian mutual fund.
Question 7: Reinvestment risk in a bond fund occurs when:
- The bond issuer defaults on payments
- Interest rates fall, forcing coupon payments to be reinvested at lower rates (Correct answer)
- The fund manager reinvests in higher-risk securities
- Currency fluctuations reduce coupon values
Correct answer: Interest rates fall, forcing coupon payments to be reinvested at lower rates
Reinvestment risk is the possibility that future coupon payments must be reinvested at lower interest rates than the original bond's yield, reducing overall returns.
IFC Risk Management 3
Systematic risk in an investment portfolio refers to: