Financial Instruments and Risk Management
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Questions and Answers

What is a primary characteristic of financial instruments?

  • They represent ownership in physical assets.
  • They are issued by borrowers to raise external funds. (correct)
  • They can only be issued by governments.
  • They are used solely for personal investments.

    • Which factor is directly related to the profitability of a financial instrument?

  • The geographical location of the issuer.
  • The current interest rates.
  • The age of the instrument.
  • The level of risk associated with it. (correct)

    • What is default risk also known as?

  • Market Risk.
  • Liquidity Risk.
  • Interest Rate Risk.
  • Credit Risk. (correct)

    • How is liquidity defined in the context of financial instruments?

    <p>The capacity to quickly convert an asset into cash with minimal costs.</p> Signup and view all the answers

    Which of the following exemplifies market risk?

    <p>A decrease in the overall market value due to economic downturns.</p> Signup and view all the answers

    Study Notes

    Financial Instruments

    • Financial instruments are issued by borrowers to obtain external funds.
    • They represent financial claims, meaning the holder has the right to receive future principal and interest payments as compensation for lending money.
    • They are also considered financial investments, representing the purchase of these instruments.

    Profitability

    • Profitability refers to the income earned from holding a financial instrument over a period of time.
    • Income includes interest, dividends, and capital gains.
    • Profitability is directly linked to risk.

    Risk

    • Risk is the potential for loss when investing in financial instruments.
    • There are several types of risk associated with financial instruments:

    Default Risk (Credit Risk)

    • This is the risk that the borrower will not repay the principal or interest on time.
    • The risk is based on the creditworthiness of the borrower.

    Market Risk

    • This is the risk that the value of the financial instrument will decrease due to changes in market conditions.
    • Examples include interest rate changes, inflation, or economic recession.

    Liquidity

    • Liquidity refers to the ability to quickly convert an asset into cash with minimal transaction costs.
    • Financial assets are generally more liquid than real assets, such as land or buildings.

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    Description

    Explore the key concepts of financial instruments, including their profitability and associated risks. This quiz covers essential terms like default risk and market risk, helping you understand how external funds are obtained and managed. Enhance your knowledge of financial investments and their implications.

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