IFC Risk Management 4 — Questions and Answers
Question 1: A fund's standard deviation is 15% while the benchmark's standard deviation is 10%. This indicates the fund:
- Outperforms the benchmark by 5%
- Has greater volatility than the benchmark (Correct answer)
- Has lower risk than the benchmark
- Generates 15% annual returns
Correct answer: Has greater volatility than the benchmark
A higher standard deviation indicates greater price volatility and therefore higher risk compared to the benchmark with its lower standard deviation.
Question 2: Under NI 81-102, what is the primary purpose of concentration limits for Canadian mutual funds?
- To maximize returns by focusing on top performers
- To limit exposure to any single issuer and reduce concentration risk (Correct answer)
- To ensure all funds hold government bonds
- To prevent investment in foreign securities
Correct answer: To limit exposure to any single issuer and reduce concentration risk
NI 81-102 imposes concentration limits (typically no more than 10% of NAV in any single issuer) to prevent excessive exposure to any one entity, reducing concentration risk.
Question 3: A risk-averse investor is best suited to a fund with:
- High beta and high standard deviation
- Low beta and low standard deviation (Correct answer)
- High leverage and concentrated holdings
- Emerging market equities and no hedging
Correct answer: Low beta and low standard deviation
Risk-averse investors prefer funds with low beta (low market sensitivity) and low standard deviation (low volatility), indicating more stable and predictable returns.
Question 4: Operational risk in a mutual fund context refers to:
- Losses from adverse market price movements
- Losses from failed internal processes, systems, or human error (Correct answer)
- Losses from borrower defaults on fund holdings
- Losses from currency fluctuations on foreign investments
Correct answer: Losses from failed internal processes, systems, or human error
Operational risk encompasses losses arising from inadequate or failed internal processes, people, systems, or external events within the fund management company.
Question 5: Which scenario represents a duration mismatch risk for a bond fund manager?
- Holding bonds of similar credit quality from different issuers
- Funding long-duration bond purchases with short-term liabilities that reprice frequently (Correct answer)
- Investing in both government and corporate bonds
- Holding bonds denominated in multiple currencies
Correct answer: Funding long-duration bond purchases with short-term liabilities that reprice frequently
Duration mismatch occurs when the fund's asset duration differs significantly from its liability duration, creating vulnerability if interest rates change and liabilities reprice before assets mature.
Question 6: A mutual fund that uses leverage to amplify returns also amplifies potential losses. What regulatory restriction applies to leverage in Canadian retail mutual funds under NI 81-102?
- Leverage is completely prohibited
- Leverage is limited through restrictions on borrowing (generally up to 5% of NAV for short-term purposes) (Correct answer)
- Leverage is unlimited if disclosed in the prospectus
- Leverage must equal at least 50% of total assets
Correct answer: Leverage is limited through restrictions on borrowing (generally up to 5% of NAV for short-term purposes)
NI 81-102 generally restricts retail mutual funds from borrowing more than 5% of NAV, and only for specific short-term purposes, strictly limiting leverage to protect investors.
Question 7: A portfolio manager concerned about political instability in a foreign country where the fund has significant investments is primarily managing:
- Credit risk
- Liquidity risk
- Country or political risk (Correct answer)
- Operational risk
Correct answer: Country or political risk
Country or political risk refers to potential losses arising from political instability, government actions, or economic disruptions specific to a particular foreign country.
IFC Risk Management 4
A fund's standard deviation is 15% while the benchmark's standard deviation is 10%.
This indicates the fund: