35. The two risks that Whitney’s is most likely exposed to given his recommendations on sectors
are:
A. interest rate risk and cap risk.
B. contingent claim risk and cap risk.
C. interest rate risk and contingent claim risk.
Answer = C
“Fixed-Income Portfolio Management – Part I,” H. Gifford Fong and Larry D. Guin
2013 Modular Level III, Vol. 4, Reading 23, Section 4.1.2.2
Study Session 9–23–j
Explain the risks associated with managing a portfolio against a liability structure, including
interest rate risk, contingent claim risk, and cap risk.
C is correct because when assets such as mortgage-backed securities have a contingent claim
provision, explicit or implicit, there is an associated risk. As rates fall, the security might have
coupons halted and principal repaid. This results in reinvestment risk and also limits any
potential upside as would be generated by a noncallable security. In addition, all fixed income
securities that have fixed rather than floating interest rates are exposed to interest rate risk,
because prices move in the opposite direction of rates.
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