LOS c: Critique the use of standard deviation, target semivariance, shortfall risk, and value at risk as measures of fixed-income portfolio risk.

Q1. An analyst is considering various risk measures to apply to a bond portfolio. He requires a measure that will use all the data so no information will be lost. Given this requirement, as he considers using the semivariance and/or value at risk, he would reject:

A)   value at risk but not the semivariance.

B)   both value at risk and the semivariance.

C)   the semivariance but not value at risk.

Q2. An analyst is considering various risk measures to apply to a bond portfolio. She requires a measure that accounts for the magnitude of the losses. Given this requirement, as she considers using the semivariance and/or shortfall risk, she would reject using:

A)   shortfall risk but not the semivariance.

B)   both shortfall risk and the semivariance.

C)   the semivariance but not shortfall risk.

Q3. An analyst is assessing the risk of a bond portfolio by applying measures of risk to the returns of the portfolio and the bonds. The portfolio includes a large position in bonds with embedded derivatives. Using the standard deviation as a risk measure for the bond portfolio is:

A)   not appropriate because the existence of the embedded derivatives would make the distribution of returns normal.

B)   not appropriate because the existence of the embedded derivatives would make the distribution of returns not normal.

C)   appropriate because the existence of the embedded derivatives would make the distribution of returns not normal.

LOS c: Critique the use of standard deviation, target semivariance, shortfall risk, and value at risk as measures of fixed-income portfolio risk. fficeffice" />

Q1. An analyst is considering various risk measures to apply to a bond portfolio. He requires a measure that will use all the data so no information will be lost. Given this requirement, as he considers using the semivariance and/or value at risk, he would reject:

A)   value at risk but not the semivariance.

B)   both value at risk and the semivariance.

C)   the semivariance but not value at risk.

Correct answer is C)

The measures to compute value at risk use all the data. The semivariance only uses the portion of data below a given value.

Q2. An analyst is considering various risk measures to apply to a bond portfolio. She requires a measure that accounts for the magnitude of the losses. Given this requirement, as she considers using the semivariance and/or shortfall risk, she would reject using:

A)   shortfall risk but not the semivariance.

B)   both shortfall risk and the semivariance.

C)   the semivariance but not shortfall risk.

Correct answer is A)

Shortfall risk gives an indication of the probability of not achieving a minimum return. The semivariance gives a measure expressed in returns.

Q3. An analyst is assessing the risk of a bond portfolio by applying measures of risk to the returns of the portfolio and the bonds. The portfolio includes a large position in bonds with embedded derivatives. Using the standard deviation as a risk measure for the bond portfolio is:

A)   not appropriate because the existence of the embedded derivatives would make the distribution of returns normal.

B)   not appropriate because the existence of the embedded derivatives would make the distribution of returns not normal.

C)   appropriate because the existence of the embedded derivatives would make the distribution of returns not normal.

Correct answer is B)

The standard deviation is a measure for normal distributions. Embedded options would make the distribution of the bond returns not normal. Therefore, the standard deviation would not be an appropriate measure.

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