Stock Advisor Risk Assessment and Management 2 — Questions and Answers
Question 1: What is 'hedging' in investment risk management?
- Investing only in low-volatility stocks
- Taking an offsetting position to reduce exposure to a specific risk (Correct answer)
- Holding cash as a buffer against market declines
- Diversifying across asset classes
Correct answer: Taking an offsetting position to reduce exposure to a specific risk
Hedging involves taking an offsetting position (such as buying put options) to reduce the potential loss from adverse price movements in another position.
Question 2: What does 'standard deviation' measure in a portfolio context?
- The average annual return of a portfolio
- The degree of variation in returns around the average, indicating volatility (Correct answer)
- The difference between the highest and lowest returns in a year
- The percentage of days the portfolio lost value
Correct answer: The degree of variation in returns around the average, indicating volatility
Standard deviation measures how widely returns are dispersed around the average return, with a higher standard deviation indicating greater volatility and risk.
Question 3: What is 'tail risk' in investment management?
- Risk from holding small-cap stocks
- The risk of rare but extreme market events that fall beyond normal probability distributions (Correct answer)
- Risk from holding a stock through its last trading day
- The risk of missing out on late-stage bull markets
Correct answer: The risk of rare but extreme market events that fall beyond normal probability distributions
Tail risk refers to the probability of extreme, low-probability events (the 'tails' of a distribution) such as a financial crisis or market crash, which can cause outsized losses.
Question 4: What is 'political risk' (country risk) for US stock investors?
- Risk from political donations by company executives
- Risk that political events, policy changes, or instability in a country negatively affect investments (Correct answer)
- Risk of SEC regulatory investigations
- Risk of earnings manipulation by politically connected boards
Correct answer: Risk that political events, policy changes, or instability in a country negatively affect investments
Political or country risk refers to the potential for investment losses due to political instability, policy changes, sanctions, or government actions in a country where a company operates.
Question 5: What does 'correlation' between assets mean for portfolio risk?
- The profit relationship between two stocks in the same industry
- A statistical measure of how two assets move in relation to each other, affecting diversification benefits (Correct answer)
- The ratio of one stock's return to another's
- The similarity of two companies' financial statements
Correct answer: A statistical measure of how two assets move in relation to each other, affecting diversification benefits
Correlation measures how two assets move relative to each other — low or negative correlation between assets reduces overall portfolio risk through genuine diversification.
Question 6: What is 'position sizing' in risk management?
- Determining a stock's total market capitalization
- Deciding how much capital to allocate to each investment relative to the total portfolio (Correct answer)
- Setting a stock's target price based on analyst estimates
- Calculating the number of shares in an index
Correct answer: Deciding how much capital to allocate to each investment relative to the total portfolio
Position sizing determines what percentage of the portfolio to allocate to each investment, balancing conviction, risk tolerance, and diversification goals.
Stock Advisor Risk Assessment and Management 2
What is 'hedging' in investment risk management?