NISM Series X-A · Unit 5 of 12 · about 7% of the paper
Managing investment risk: NISM Series X-A notes and practice questions
Risk is more than volatility. This unit lists the types of risk and the tools to measure and manage them.
What to know in Unit 5
- Types of risk.
- Standard deviation and beta.
- Diversification and risk management steps.
Key terms, examples and exam traps
Market risk
Market risk is the risk of loss from overall movements in market prices that cannot be diversified away.
Example. A portfolio falls because the whole market fell.
Exam trap. This statement is false: Market risk can be eliminated by diversification.
Credit risk
Credit risk is the chance that a borrower will not repay interest or principal on time.
Example. A bond issuer defaults on interest payments.
Exam trap. This statement is false: Credit risk applies only to equity shares.
Interest rate risk
Interest rate risk is the risk that changes in interest rates will affect the value of fixed-income investments; prices fall when rates rise.
Example. A bond portfolio loses value after the policy rate is raised.
Exam trap. This statement is false: Bond prices rise when interest rates rise.
Inflation risk
Inflation risk is the risk that returns will not keep pace with price rises, eroding purchasing power.
Example. A saver's 5% deposit returns less than the 6% inflation.
Exam trap. This statement is false: Inflation risk affects only equity investors.
Liquidity risk
Liquidity risk is the risk of being unable to sell an asset quickly at a fair price.
Example. A client cannot sell a plot of land at short notice.
Exam trap. This statement is false: Liquidity risk is the chance of a price fall.
Reinvestment risk
Reinvestment risk is the risk that cash flows such as coupons can only be reinvested at lower rates than the original.
Example. A bond's coupons are reinvested at lower rates after rates fall.
Exam trap. This statement is false: Reinvestment risk is the risk of default.
Systematic and unsystematic risk
Systematic risk affects the whole market and cannot be diversified; unsystematic risk is specific to a company or sector and can be reduced by diversification.
Example. A strike at one company is specific risk, while a recession affects all.
Exam trap. This statement is false: Systematic risk can be diversified away.
Standard deviation
Standard deviation measures how widely returns vary around the average and is used as a measure of total risk.
Example. A fund with a standard deviation of 20% is more volatile than one with 10%.
Exam trap. This statement is false: A higher standard deviation indicates lower risk.
Beta
Beta measures a security's sensitivity to market moves; beta above 1 means more volatile than the market.
Example. A stock with a beta of 1.4 tends to move more than the market.
Exam trap. This statement is false: A beta of 1 means the stock never moves.
Diversification
Diversification reduces unsystematic risk by holding assets that do not move together, such as equity, debt and gold.
Example. An investor spreads money across asset classes and sectors.
Exam trap. This statement is false: Diversification eliminates all risk.
Risk tolerance
Risk tolerance is a client's willingness to accept fluctuations; it differs from risk capacity, which is the ability to bear loss.
Example. A client who loses sleep over a small fall has low tolerance.
Exam trap. This statement is false: Risk tolerance is a fixed number set by regulation.
Risk management process
Risk management involves identifying risks, measuring them, choosing a treatment such as avoiding, reducing, transferring or retaining and monitoring.
Example. A family buys health insurance to transfer the risk of a large medical bill.
Exam trap. This statement is false: Risk management means ignoring all risks.
Value at Risk
Value at Risk estimates the maximum likely loss over a period at a given confidence level under normal conditions.
Example. A portfolio's one-day 95% VaR is ₹2 lakh.
Exam trap. This statement is false: VaR is the worst possible loss ever.
Risk-adjusted return
Risk-adjusted measures such as the Sharpe ratio show return earned per unit of risk taken.
Example. Two funds with equal returns are compared on how much risk each took.
Exam trap. This statement is false: The highest-return fund always has the best risk-adjusted performance.
6 practice questions
Read each question and choose your answer before opening the free mock, which shows the correct answer and the reason.
Q1. Which statement best describes “Standard deviation”?
- The clearing corporation guarantees the settlement of exchange trades, reducing counterparty risk for investors.
- Tax deducted at source is tax withheld by the payer on specified payments such as salary and interest, and credited to the payee's tax account.
- Third-party motor insurance is mandatory in India and covers liability to others; comprehensive cover also covers damage to own vehicle.
- Standard deviation measures how widely returns vary around the average and is used as a measure of total risk.
Q2. Which statement best describes “Credit risk”?
- A net worth statement lists assets and liabilities; net worth equals assets minus liabilities.
- Credit risk is the chance that a borrower will not repay interest or principal on time.
- A sovereign gold bond is a government security denominated in grams of gold that pays interest and has no storage or purity issues, with a defined tenure.
- An endowment plan combines life cover with savings and pays on maturity or earlier death, with lower cover and returns than term plus investment.
Q3. Which term is described here? Interest rate risk is the risk that changes in interest rates will affect the value of fixed-income investments; prices fall when rates rise.
- Interest rate risk
- Annual audit
- TDS
- Real estate
Q4. Which term is described here? Beta measures a security's sensitivity to market moves; beta above 1 means more volatile than the market.
- Beta
- Senior Citizens' Savings Scheme
- Behavioural biases
- PFRDA
Q5. Which term is described here? Liquidity risk is the risk of being unable to sell an asset quickly at a fair price.
- Market risk of equity
- Market risk
- Liquidity risk
- Risk-adjusted return
Q6. Which statement best describes “Reinvestment risk”?
- Active investing tries to beat a benchmark through selection; passive investing tracks it at low cost.
- A recurring deposit lets a saver deposit a fixed sum every month for a fixed term, earning a fixed interest rate.
- Reinvestment risk is the risk that cash flows such as coupons can only be reinvested at lower rates than the original.
- Home insurance covers loss or damage to the structure and contents from specified perils such as fire and flood.
Frequently asked questions
How much of NISM Series X-A comes from Unit 5?
Unit 5 (Managing investment risk) usually carries about 7% of the questions. The whole exam has 100 questions and the pass mark is 60%.
What should I study in NISM Series X-A Unit 5?
Types of risk. Standard deviation and beta. Diversification and risk management steps.
Are these NISM Series X-A practice questions free?
Yes. Take the full free mocks to see the correct answer and the reason for every question.
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