What type of risk were mortgage-backed securities designed to address?
Answer(s): D
Mortgage-Backed Securities (MBS) are designed to address prepayment risk, which arises when borrowers pay off their mortgages earlier than expected. Prepayments reduce the interest income investors receive and can affect the expected return on the security.Why Prepayment Risk is Addressed:Prepayment often occurs when interest rates decline, as borrowers refinance their mortgages. This leaves MBS investors reinvesting at lower yields, which impacts returns.Structuring MBS helps mitigate prepayment risk through mechanisms like tranches in Collateralized Mortgage Obligations (CMOs).Explanation of Options:A . Liquidity: Incorrect. MBS provides liquidity to lenders but is not designed to address liquidity risk directly.B . Interest Rate: Incorrect. MBS investors are still exposed to interest rate risk as rates impact prepayment behavior.C . Rollover: Incorrect. Rollover risk applies to short-term debt securities, not MBS.D . Prepayment: Correct. MBS structures are specifically designed to mitigate the impact of prepayments on investors.
CSC Volume 2, Chapter 23: Risks of structured products, particularly prepayment risks in MBS.
A business trust would typically purchase the underlying company assets of which type of operation?
Answer(s): B
A business trust typically acquires the operating assets of businesses such as restaurants, which generate predictable and steady cash flows. Business trusts focus on distributing income to unitholders, and restaurant operations align well with this goal due to their recurring revenue models.Explanation of Options:A . Senior Housing: More common for real estate investment trusts (REITs), not business trusts.B . Restaurants: Correct. Restaurants are suitable for business trusts because of their stable cash flow potential.C . Industrial Rentals: Typically under REITs, not business trusts.D . Shopping Centres: Also more commonly associated with REITs.
CSC Volume 2, Chapter 22: Business trusts and the types of operations they typically invest in.
What industry stocks tend to have lower betas than the market?
Answer(s): C
Beta is a measure of a stock's volatility compared to the overall market. Stocks with lower betas tend to experience smaller price fluctuations relative to the market.Utilities:Utility companies generally have stable and predictable revenue streams because they provide essential services like electricity, water, and gas, which are always in demand regardless of economic cycles. As a result, utility stocks have lower betas, reflecting their lower sensitivity to market movements.Why Other Options Are Incorrect:A . Transportation: Stocks in this sector are more sensitive to economic changes and fuel prices,leading to higher betas.B . Capital Goods: This sector involves investments in industrial equipment and machinery, which fluctuate with economic cycles and have higher betas.D . Automobiles and Components: This industry is cyclical and highly dependent on economic trends, leading to higher betas.
CSC Volume 2, Chapter 13: Risk and return in specific industries.
After reviewing a client's risk tolerance, time horizon and financial objectives. Andy recommends that a long-term asset mix of 55% equities, 40 bonds and 5% cash would be most appropriate for the client.Which approach has Andy taken in his recommendation?
Strategic asset allocation is a long-term approach to portfolio management where a target allocation among asset classes (e.g., equities, bonds, cash) is established based on the client's risk tolerance, time horizon, and financial objectives. This allocation remains relatively constant over time, with periodic rebalancing to maintain the original proportions.Details of Andy's Recommendation:Andy recommends a fixed asset mix of 55% equities, 40% bonds, and 5% cash, which aligns with the principles of strategic asset allocation. The focus is on maintaining this allocation to meet long-term goals, without frequent shifts based on short-term market movements.Why Other Options Are Incorrect:A . Dynamic asset allocation: This involves frequent changes to asset allocation in response to market trends, which is not evident in Andy's recommendation.B . Tactical asset allocation: This is a short-term, active approach where adjustments are made based on market conditions to capitalize on opportunities.D . Ongoing asset allocation: While this involves periodic rebalancing, it is not a defined approach like strategic allocation.
CSC Volume 2, Chapter 16: Asset allocation strategies.
What is a structured product?
A structured product is a pre-packaged investment strategy often involving derivatives and fixed- income securities to offer a combination of protection and growth potential.Principal-Protected Note (PPN):A PPN is a common type of structured product that guarantees the return of the original investment (principal) at maturity while offering potential upside linked to the performance of an underlying asset or index.Why Other Options Are Incorrect:A . A mortgage loan: This is a form of debt, not a structured product.C . An equity index: An index tracks the performance of a market but is not a structured product itself.D . A credit card receivable: This is a financial asset used in securitization, not a structured product.
CSC Volume 2, Chapter 23: Structured products and their features.
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