Types of Investment Risk - Answers and Explanations

  1. "B" - I, III & IV. Because the hedge fund makes investments abroad, political risk is present, particularly in the burgeoning capital markets of the Baltic states; currency risk is present as Byrum is a dollar based investor and the strength or weakness of the dollar relative to the other currencies could impact return; business risk unique to the individual companies is present as well.
  2. "D". Tax risk. Because municipal bonds are tax-advantaged, of the choices given, the risk that federal legislation could in some manner mitigate the tax benefits of these fixed income securities is the best choice.
  3. "D". All of the risks enumerated apply to fixed income in general. Sovereign risk is unique to sovereign credits and would be the exception in this question.
  4. "C". Business Risk. The shelving of the project could materially impact revenues and is a source of business risk to which markets could react unfavorably.
  5. "A". Pimental needs to be concerned most with loss of principal. The question does not reveal the beneficial owner's age, who could be as young as two or as old as seventeen. The shorter time horizon to invest for a secondary education would dictate the need for growth, but of paramount concern would be to preserve principal.
  6. "B". Market risk is systematic and hence, non-diversifiable.
  7. "D". All of the items listed in the question are examples of events that could impact the company's ability to service its debt. Event risk may or may not lead to default.
  8. "C". Money market is the best choice here. Other than the laddering, all of the remaining examples are high risk and, given that we no nothing further about a particular senior's circumstances, the safe assumption is valid.
  9. "C". STRIPS, privately created zero coupon bonds from US government securities which carry no default risk and no sovereign risk.
  10. "A". Inflation Risk. Hedge funds, in general, seek to enhance returns by employing more complex strategies which are not as susceptible to the longer term risk of inflation.
  11. "A". Lower rated credits are, all else being equal, more susceptible to default risk.
  12. "B". The stock fund is the best inflation hedge and ranks first, Commercial paper is very short term and most susceptible to inflation.
  13. "D". Private equity does not trade publicly. Market risk would not be applicable and, because it is a subset of total risk, which would not apply either. Business risk and the possibility of it leading to capital impairment would be the best choice.
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