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Answer: A portfolio of mezzanine tranche MBS structured by a large regional bank
The portfolio of mortgage-backed securities (MBS) would likely have the highest potential level of unexpected loss during a sharp broad-based downturn in financial markets. This is because MBS are sensitive to changes in interest rates and housing market conditions, which can lead to increased defaults and prepayments. During a crisis, these factors can result in a higher correlation (covariance) among the securities, meaning they are more likely to move downward simultaneously. This increases the risk of unexpected losses compared to the other options listed, which have different risk profiles and are less likely to be affected in the same way by a market downturn.
Author: LeetQuiz Editorial Team
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A pension fund's risk manager is responsible for evaluating the risk profiles of different portfolios that the fund holds. These various portfolios are diversified across multiple asset classes and currently possess the same market value. Given these conditions, if there were to be a major, economy-wide financial downturn, which of the portfolios would likely incur the highest level of unexpected losses?
A
A portfolio of US Treasury notes with 2 to 5 years to maturity
B
A portfolio of long stock positions in an international large cap stock index combined with long put options on the same index
C
A portfolio of mezzanine tranche MBS structured by a large regional bank
D
A short position in futures for industrial commodities such as copper and steel
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