Financial Risk Manager Part 1
Get started today
Ultimate access to all questions.
The relationship between risk and return is simple for some assets and complex for others. The public perception of risk and return trade-off is that higher risk will lead to higher returns. However, in some asset classes like fixed-income securities, a large number of factors such as market risk, inflation, interest rate risk, and risk tolerance are considered. Which of the following options is most appropriate for a market with investors having a high risk tolerance?
Other
Community
TTanishq
A
As the risk tolerance of investors is high, more investors will choose corporate bonds over government bonds
B
As the risk tolerance of investors is high, more investors will choose government bonds over corporate bonds
C
As the risk tolerance of investors is high, all investors will choose a good mix of corporate and government bonds
D
As the risk tolerance of investors is high, all investors will choose not to buy corporate bonds
Explanation:
When investors have a high tolerance for risk, they are more likely to invest in assets that offer higher potential returns despite the increased risk. Corporate bonds typically offer higher yields than government bonds to compensate for the additional risk. This risk comes from the possibility that the issuing corporation may default on its obligations. Therefore, in a market where investors have a high risk tolerance, it is reasonable to expect that more investors will choose corporate bonds over government bonds. This is because these investors are willing to accept the higher risk associated with corporate bonds in exchange for the potential of higher returns.
Choice B is incorrect. This choice suggests that investors with a high risk tolerance would prefer government bonds over corporate bonds. However, this contradicts the general understanding of risk and return in finance. Government bonds are typically considered safer investments with lower returns, while corporate bonds carry higher risk but also offer higher potential returns. Therefore, investors with a high tolerance for risk would be more likely to choose corporate bonds over government ones.
Choice C is incorrect. While it's true that diversification can help manage risk, this choice assumes that all investors will choose a mix of corporate and government bonds regardless of their individual risk tolerances. This is not necessarily the case as some high-risk tolerant investors might prefer to invest more heavily in higher-risk assets like corporate bonds for potentially greater returns.
Choice D is incorrect. This option suggests that all high-risk tolerant investors will avoid buying corporate bonds altogether which contradicts the basic principles of investment theory where higher risks are associated with potentially higher returns. Investors who have a high tolerance for risk are generally more willing to invest in risky assets such as corporate bonds because they offer the potential for greater return.
Comments
Loading comments...