Stock Jobs Risk Management in Securities 2 — Questions and Answers
Question 1: In risk management, what does standard deviation measure for a portfolio?
- The average return of the portfolio over time
- The degree of variation in the portfolio's returns, indicating its volatility (Correct answer)
- The portfolio's performance relative to a benchmark index
- The maximum amount of capital allocated to a single security
Correct answer: The degree of variation in the portfolio's returns, indicating its volatility
Standard deviation quantifies how much a portfolio's returns deviate from its mean return, making it a key measure of investment risk and volatility.
Question 2: What does the Sharpe Ratio measure?
- The total return of a portfolio over a fiscal year
- The risk-adjusted return of a portfolio relative to the risk-free rate (Correct answer)
- The correlation between two different stocks in a portfolio
- The maximum drawdown experienced by a portfolio over a period
Correct answer: The risk-adjusted return of a portfolio relative to the risk-free rate
The Sharpe Ratio calculates how much excess return an investor receives for each unit of risk (standard deviation) taken above the risk-free rate.
Question 3: What is the purpose of stress testing in risk management?
- To evaluate how well traders perform under deadline pressure
- To simulate extreme market conditions to assess a portfolio's potential losses (Correct answer)
- To test the speed and accuracy of trade execution systems
- To measure how quickly a portfolio manager can rebalance holdings
Correct answer: To simulate extreme market conditions to assess a portfolio's potential losses
Stress testing models how a portfolio would perform under severe hypothetical scenarios (e.g., a market crash or interest rate spike) to identify vulnerabilities.
Question 4: What is liquidity risk in securities markets?
- The risk that a company will run out of cash to pay dividends
- The risk that an investor cannot sell a security quickly at a fair market price (Correct answer)
- The risk that interest rates will change, affecting bond prices
- The risk of losses due to currency exchange rate fluctuations
Correct answer: The risk that an investor cannot sell a security quickly at a fair market price
Liquidity risk is the danger that an investor will not be able to execute a transaction at the current market price due to insufficient market activity or depth.
Question 5: A margin call occurs when:
- A broker recommends buying additional shares of a stock
- An investor's account equity falls below the required maintenance margin level (Correct answer)
- A stock's price rises above the investor's target sell price
- A company announces a stock buyback program
Correct answer: An investor's account equity falls below the required maintenance margin level
A margin call is issued when the equity in a margin account falls below the broker's maintenance margin requirement, requiring the investor to deposit more funds or sell securities.
Question 6: Which risk management concept refers to the sensitivity of a bond's price to changes in interest rates?
- Beta
- Alpha
- Duration (Correct answer)
- Convexity
Correct answer: Duration
Duration measures how much a bond's price is expected to change for a 1% change in interest rates; bonds with higher duration are more sensitive to rate changes.
Question 7: What is counterparty risk?
- The risk that a competitor firm will undercut your trading profits
- The risk that the other party in a financial transaction will fail to fulfill their obligations (Correct answer)
- The risk of purchasing a security at a price higher than its intrinsic value
- The risk associated with holding securities in foreign markets
Correct answer: The risk that the other party in a financial transaction will fail to fulfill their obligations
Counterparty risk is the possibility that the other party in a trade or contract will default before the transaction is settled or the contract is fulfilled.
Stock Jobs Risk Management in Securities 2
In risk management, what does standard deviation measure for a portfolio?