A registered representative is reviewing a client's investment portfolio consisting of a diverse mix of large-cap domestic equities and long-term fixed-rate corporate bonds. The client wants to understand how systemic macroeconomic shifts could impact their holdings despite extensive diversification. Which of the following statements regarding the systematic risk exposure of this portfolio are TRUE?
- Extensive asset diversification across hundreds of equity positions cannot eliminate the portfolio's exposure to overall market risk.Answer
- BHolding long-term Treasury securities in place of corporate bonds completely eliminates systematic interest rate risk because Treasuries carry zero default risk.
- Purchasing broad-market index put options can serve as a systemic risk hedge to protect the equity portion against a widespread market decline.Answer
- DWhen prevailing market interest rates rise during a central bank tightening cycle, the market prices of the portfolio's existing fixed-rate bonds will increase.
Answer
Extensive diversification does not eliminate systematic market risk, and purchasing broad-market index put options is an effective hedging strategy against broad market downturns.
The correct statements recognize that systematic risk (market risk) affects the market as a whole and cannot be eliminated by adding more individual stocks, and that hedging via index options is a valid risk-mitigation strategy for systematic risk.
Step-by-Step Solution
Key Concept
Systematic risk (market, interest rate, inflation risk) affects the entire market, cannot be diversified away, and must be managed via hedging strategies like index options.
Estimated Time:2m 0s