NASAA Series 65, Uniform Investment Adviser Law ExaminationInvestment Vehicle CharacteristicsEasy
A portfolio manager is evaluating the risk exposure of a client's fixed-income portfolio. The client holds several long-term corporate bonds. The manager is particularly concerned about the possibility that the bond issuers may be unable to make their promised interest payments or repay the principal at maturity. Which type of risk is the manager primarily assessing?
- APurchasing Power Risk
- BInterest Rate Risk
- CLiquidity Risk
- DDefault Risk
Show answer & explanationAnswer & explanation
Correct answer: D. Default Risk
Default risk, also known as credit risk, is the risk that a bond issuer will be unable to make interest payments or repay the principal, directly matching the manager's concern.
Why the other options are wrong
- A. Purchasing power risk (inflation risk) is the risk that inflation will erode the value of a bond's future payments, not related to issuer default.
- B. Interest rate risk is the risk that changes in market interest rates will affect a bond's value, not the issuer's ability to pay.
- C. Liquidity risk is the risk that an investment cannot be quickly converted into cash without a significant loss in value, not the issuer's ability to pay.
Default Risk (Credit Risk)
The risk that a bond issuer will be unable to make its promised interest payments or repay the principal amount at maturity.
- Also known as credit risk
- Higher for lower-rated bonds
- Can lead to loss of principal and interest income
Memory trick: Default Risk: Did the company Fail to pay?