Why does the foreign and domestic debt instrument not apply to the exchange risk?
1 Like
Is this in reference to a specific question? If so, can you paste it here? Generally speaking, foreign securities will be subject to exchange risk.
2 Likes
This is a question from FINRA SIE sample exam.
All of the following risks apply to both foreign and domestic debt instruments EXCEPT:
a. political
b. exchange
c. repayment
d. interest rate
not sure why the answer is B.
1 Like
Good question - the key word in the question is both. While foreign debt instruments will be subject to exchange risk, domestic debt instruments are not. FYI - currency exchange risk applies anytime an investor is required to exchange one currency for another. This will always occur when investing in foreign securities. However, it does not apply to domestic debt securities.
The answer is D because all debt securities, regardless of whether they’re foreign or domestic, are subject to interest rate risk (interest rates up, bond prices down).
2 Likes
maybe there’s a mistake because on the SIE practice exam, the right answer is actually B!
1 Like
Oh haha - I just realized I missed the except. Let me clear up what I said above.
A - Political risk typically only applies to foreign governments, but the textbook definition is “instability in a political system causing the value of a security to fall.” Technically, we could see this occur in the US, so I believe that’s their argument. However, I would still assume you’re more likely to experience political risk with foreign investments.
B - Exchange risk will apply to foreign securities, but not domestic securities. Therefore we couldn’t say it applies to both.
C - Repayment risk is probably alluding to credit (default) risk, especially if the issuer is unable to pay back the borrowed funds after issuing a bond.
D - Interest rate risk applies to all types of bonds
Sorry for missing the except!
2 Likes