NASAA Series 66 Uniform Combined State Law ExaminationClient Investment Recommendations and StrategiesMedium
A client is evaluating an investment in a private equity fund. They are concerned about the inability to sell their shares quickly if they need access to capital. This concern primarily relates to which of the following investment characteristics?
- ASystematic risk
- BLiquidity risk
- CCredit risk
- DInflation risk
Show answer & explanationAnswer & explanation
Correct answer: B. Liquidity risk
Liquidity risk is the risk that an investment cannot be bought or sold quickly enough to prevent a loss or meet a financial obligation, which is a common concern with private equity funds due to their illiquid nature.
Why the other options are wrong
- A. Systematic risk (market risk) is the risk of loss due to factors affecting the entire market, not specific to an individual investment's tradability.
- C. Credit risk is the risk that a bond issuer will default on its obligations, not relevant to the inability to sell private equity shares.
- D. Inflation risk is the risk that inflation will erode the purchasing power of an investment's returns, not related to the ease of selling.
Liquidity Risk
The risk that an asset cannot be converted into cash quickly without a significant loss in value.
- Common in private investments like real estate and private equity.
- Higher for assets with thin trading markets.
- Can impact an investor's ability to meet short-term financial needs.
Memory trick: Losing Liquidity means you're Locked up.