A financial advisor is conducting a risk review of a client's fixed-income portfolio, which consists of corporate bonds issued by a single retail chain, municipal revenue bonds backed by toll road fees, and 10-year U.S. Treasury notes. Which TWO of the following statements regarding the non-systematic and credit risks of this portfolio are correct?
- The corporate bonds carry business risk and credit risk specific to the financial condition and sales performance of the issuing retail company.Answer
- BThe U.S. Treasury notes carry significant credit risk because their market values decline when prevailing interest rates rise.
- The creditworthiness of the municipal revenue bonds depends on the volume of toll road traffic and fees collected rather than general municipal tax revenues.Answer
- DDiversifying the corporate bond holdings across multiple commercial sectors will eliminate the portfolio's overall interest rate risk.
Answer
The correct statements are that the corporate bonds carry business and credit risk specific to the retail issuer, and that the municipal revenue bonds' creditworthiness depends on the project's toll revenues.
Corporate bonds carry non-systematic risks directly tied to the issuer's financial stability and operational success. Municipal revenue bonds depend entirely on the cash flows generated by the specified facility (e.g., toll road receipts), making their credit risk specific to that facility's revenue stream.
Step-by-Step Solution
Key Concept
Non-Systematic and Credit Risks