jawz

Which of the following statements regarding liquidity risk is NOT correct?

A) Liquidity risk is not important to an investor who intends to hold a security until maturity.

B) Emerging markets typically have more liquidity risk than established markets.

C) The bid-ask spread is one measurement of liquidity risk.

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Even if an investor intends to hold securities to maturity, liquidity risk impacts portfolios when marking to market and through changes in investor tastes and preferences over time. For example, liquidity is important to institutional investors that must determine market values for net asset values (NAVs) and to dealers in the repurchase market for collateral valuation.
A narrow bid-ask spread indicates a liquid asset, while a wide bid-ask spread indicates an illiquid asset. For example, the spreads on recently issued Treasury securities are often only a few basis points. Emerging markets are usually less liquid than established markets, one reason being the small trading volumes.

jawz

Which of the following statements does NOT describe a characteristic of an illiquid asset or market?

A) Large block trades that do not materially affect prices.

B) Small trading volumes.

C) Wide bid-ask spreads.

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In a liquid market with large trading volumes, large block trades should not affect prices. The other choices are characteristics of illiquid markets or assets.

jawz

Which of the following assets is the least liquid?

A) Foreign exchange futures contract.

B) On-the-run Treasury security.

C) Limited Partnership.

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All other choices are considered highly liquid assets. On-the-run Treasuries are recently issued and are often more liquid than older issues.

jawz

Which of the following statements about liquidity risk is least accurate?

A) A lack of liquidity may make it difficult to determine the value of a security.

B) Liquidity risk and the bid-ask spread are not relevant to an investor who is planning to hold a security to maturity.

C) The bid-ask spread is an indication of the liquidity of a security.

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Even if the investor plans to hold the security until maturity rather than trade it, poor liquidity can have adverse consequences stemming from the need to periodically mark securities to market. When a security has little liquidity, the variation in dealers’ bid prices (or a lack of bids) makes valuation more difficult. Bid-ask spreads tend to be narrower for more liquid securities and wider for less liquid securities.

jawz

Assume there are two investors, one in the U.S. and one in Switzerland. In the context of bond investments, appreciation in the Swiss franc benefits the:

A) U.S. investor holding Swiss bonds.

B) U.S. investor holding U.S. bonds.

C) Swiss investor holding U.S. bonds.

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The appreciation of the foreign currency (Swiss franc) benefits domestic investors (U.S. citizens) who own foreign (Swiss) bonds. When the Swiss franc appreciates, each Swiss franc buys more of the U.S. dollar than before. Here, the U.S. investor gains by owning foreign bonds because the investor realizes not only the return from the bond but also a gain from the foreign currency appreciation. The return realized by the Swiss investor holding U.S. bonds is decreased by the depreciation of the U.S. dollar against the Swiss franc.

jawz

Which of the following statements about currency risk is most accurate? Generally:

A) if the foreign currency appreciates, the foreign cash flow will be worth less for the domestic investor.

B) appreciation of the foreign currency is good for domestic investors who buy foreign securities.

C) if the home currency appreciates against the foreign currency, each foreign currency unit will be worth more in terms of the home currency.

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If the home currency appreciates against the foreign (i.e., payment) currency, each foreign currency unit will be worth less in terms of the home currency. If the foreign currency appreciates, a given foreign cash flow will be worth more units of the home currency, thereby benefiting the domestic investor holding foreign securities.

jawz

Which of the following statements concerning the exchange rate risk of investing in foreign bonds is most accurate? If the foreign currency:

A) appreciates, the bond's coupon increases.

B) depreciates, the bond's coupon payments will turn into more U.S. dollars.

C) depreciates, bond investors lose, all else equal.

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If the foreign currency depreciates, bond investors lose, all else equal. This occurs because the bond’s coupon payments and principal will convert to fewer U.S. dollars.

jawz

Which of the following statements is NOT correct?

A) Exchange-rate risk may benefit a bond investor.

B) The depreciation of foreign currency benefits domestic investors who buy foreign securities.

C) An investor who purchases a foreign bond gains the most when both the asset and the foreign currency appreciate in value.

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This statement should read, "The appreciation of foreign currency benefits domestic investors who buy foreign securities." The other choices are correct. Exchange rate risk creates uncertainty for the investor, but is not always bad for the investor. If a domestic investor purchased a foreign currency denominated bond, appreciation in the foreign currency would benefit the investor.

jawz

While serving as visiting conductor at the University of Edinburgh, U.S. Citizen William Golson purchases a 9.0% annual coupon bond denominated in the local currency for 93.0. One year later, before his return to the U.S., he sells the bond for 99.5. Using a holding period return formula he remembers from his undergraduate studies, he calculates his return at 16.7%. On the flight home, he is seated next to Kristin Meyer, CFA. She is puzzled because she has heard that similar investments yielded negative returns over the same time period. After consulting her financial newspaper, she recalculates Golson’s return at a disappointing negative 5.2%.
Assuming Meyer is correct, which of the following statements is the most likely reason for the difference in the calculated returns? Golson:

A) forgot to include the impact of foreign currency depreciation in relation to the dollar.

B) forgot to include the impact of foreign currency appreciation in relation to the dollar.

C) omitted the impact of inflation.

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Golson most likely forgot to take into account the impact of the percentage change in the dollar value of the foreign currency. Here, since the correct return (calculated by Meyer) is lower than that calculated by Golson (who omitted the impact of foreign exchange), the foreign currency depreciated in relation to the dollar. The appreciation in the bond value was not enough to offset the currency depreciation, and the total return in dollar terms was negative. Calculating the total dollar return on a bond is discussed in more detail later in Study Session 18.

jawz

While working abroad, U.S. citizen Dirk Senik purchases a foreign bond with an annual coupon of 7.5% for 95.5. One year later, the exchange rate between the dollar and the foreign currency remains unchanged and he sells the bond for 97.25, resulting in a holding period return of 9.7%. If the foreign currency had depreciated in relation to the dollar, Senik’s return would be:

A) less than 9.7%.

B) greater than 9.7%.

C) equal to 9.7%.

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The return on a foreign bond is a combination of the return on the bond and the movement in the foreign currency. In the base case, the movement in the foreign security was 0 and thus the return was just the holding period return on the bond. If the foreign currency depreciates, the return will be lowered because the investor will lose upon conversion to the dollar.