Which of the following risks is inherent in this portfolio?

The portfolio is varied so I don’t understand why the answer was nonsystematic. Can someone explain this to me?


Hi @Pleasant_copper_hors! Thanks for posting.

This is one of the questions from FINRA’s SIE practice exam, which is a great resource for SIE test takers. It’s a 75 question practice exam directly from the source!

In regards to this question, let’s pick it apart answer by answer:

Choice A: Credit (default) risk occurs when there’s a risk of not receiving scheduled interest or principal payments from an issuer. In particular, this risk applies to debt securities. The portfolio only has one debt-related security - money market funds. Money markets are high quality, short term debt securities that mature within 1 year or less. Funds are typically comprised of dozens, if not hundreds of securities. Given the diversification of the fund, the high quality aspect of money markets, and the fact the money market fund only comprises 10% of the overall portfolio, credit risk is very low in this portfolio.

Choice B: Liquidity risk occurs when a security is unable to be sold, or can only be sold with a deep discount to its value. Funds (including mutual funds and ETFs) typically do not face liquidity risk. Mutual funds are redeemable, allowing investors to always perform transactions with the issuer. ETFs are exchange traded, and exchanges make sure the securities trading on their platforms may be bought and sold with relative ease. The other two investments are individual securities. They do not give us any indication of whether or not they trade on exchanges, so we cannot be 100% clear on whether liquidity risk exists for this 60% portion of the portfolio. Answer choice B is a maybe.

Choice C: Political risk occurs when a change in government adversely affects a security. In particular, this risk is most applicable to foreign investments. Given this portfolio has no foreign investments, portfolio risk does not apply.

Choice D: Non-systematic risk is a category of risk that applies to one security or a small portion of the market. This can be compared to systematic risks, which apply to the general broad market. For non-systematic risk to be the answer, we must demonstrate the portfolio could be subject to large amounts of risk that apply to individual securities or small sectors of the market. Given 60% of the portfolio is invested in two individual common stocks (ABC Energy Company and XYZ Health Care Company), this argument can easily be made. If either of these companies experience risks applicable to only to their company or sector (e.g. business risk, financial risk, or regulatory risk), they could experience a large decline in value.

After going through all the answer choices, the only two that could be correct are answer choices B and D. Answer choice B only could apply if the individual securities (ABC and XYZ) are not exchange traded (trading in the non-NASDAQ OTC markets). It’s not clear, which is why B is a maybe. Answer choice D definitely applies given 60% of the portfolio is invested in two individual stocks. The less diversified a portfolio, the more it’s subject to non-systematic risk.

Bottom line - D is the best answer.

I hope this helps! Please respond if you have any questions.