CPS Risk Management in Portfolios 2 — Questions and Answers
Question 1: What is 'concentration risk' in a portfolio?
- Risk from owning too many securities
- Risk from having too large a position in a single security or sector (Correct answer)
- Risk of over-diversification
- Risk from using index funds
Correct answer: Risk from having too large a position in a single security or sector
Concentration risk arises when a portfolio has too much exposure to a single investment, sector, or geographic region.
Question 2: What is 'liquidity risk' in portfolio management?
- The risk of having too much cash
- The risk of not being able to sell an asset quickly at fair value (Correct answer)
- The risk of excessive trading
- The risk of interest rate changes
Correct answer: The risk of not being able to sell an asset quickly at fair value
Liquidity risk is the possibility that an investment cannot be sold quickly enough or at a fair price when needed.
Question 3: What is 'credit risk' in the context of bond investing?
- The risk of rising interest rates
- The risk that a bond issuer will default on payments (Correct answer)
- The risk of currency devaluation
- The risk of inflation outpacing returns
Correct answer: The risk that a bond issuer will default on payments
Credit risk is the probability that a bond issuer will fail to make required interest or principal payments.
Question 4: Which risk management technique involves setting a predetermined price to automatically sell a position?
- Buy and hold strategy
- Stop-loss order (Correct answer)
- Rebalancing trigger
- Margin call
Correct answer: Stop-loss order
A stop-loss order automatically sells a security when its price falls to a predetermined level, limiting downside losses.
Question 5: What is 'inflation risk' (purchasing power risk) in a portfolio?
- The risk that investments grow too fast
- The risk that returns will not keep pace with inflation (Correct answer)
- The risk of deflation harming bond returns
- The risk of currency appreciation
Correct answer: The risk that returns will not keep pace with inflation
Inflation risk is the danger that investment returns will be eroded by inflation, reducing the portfolio's real purchasing power.
Question 6: How does geographic diversification help manage portfolio risk?
- It eliminates currency risk entirely
- It reduces exposure to any single country's economic or political events (Correct answer)
- It guarantees higher returns
- It only benefits equity investors
Correct answer: It reduces exposure to any single country's economic or political events
Geographic diversification reduces the impact of country-specific economic downturns, political instability, or regulatory changes on the overall portfolio.
CPS Risk Management in Portfolios 2
What is 'concentration risk' in a portfolio?