Questions and Answers
What are sterling bonds to foreign borrowers?
This is a bond market with the UK market selling sterling loans to foreign governments and companies.
What is a Eurobond and give an example of a Euroyen bond.
A Eurobond is an international bond denominated in a currency other than that of the country where it is issued, such as a UK company issuing a Eurobond in America in Japanese Yen.
Name 2 bond indices.
FTSE Actuaries UK Gilt Index for domestic bonds and Barclays Capital Aggregate Bond Index for global bonds.
The yields on bonds measure what?
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Which two bond yields are regularly published in the financial press?
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What are some other names for interest yield?
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The coupon is based on £100 of stock, however the interest yield formula is what?
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Why can the interest yield formula be misleading?
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Which is the most accurate calculation for the yield of a bond and what does it take into account?
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When does the capital gain or loss on a bond take place?
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Why is the redemption yield tough to calculate?
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Where the redemption yield is less than the interest yield there will be capital loss if the bond is held until ____.
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While the redemption yield helps to compare bonds on a common basis, this is not useful for the common investor because it does not take into account what?
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Which bonds tend to be tax free?
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How do yields on collective funds work?
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What are the key risks to bonds?
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Describe the interest rate risk with bonds.
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Describe the liquidity risk with bonds.
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Describe the inflation risk with bonds and what is a good method to protect.
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Describe currency risk with bonds.
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Describe the default risk with bonds.
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What determines the market price of a bond?
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What are the two broad factors that affect bond prices?
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Why are government bonds considered the most secure?
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What is the lowest investment grade rating in both Standard & Poor's and Moody's?
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What are the ratings for non-investment grade bonds and other names for the same?
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What is the very worst bond rating in S&P vs. Moody's?
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Name examples of market or systemic risk of bonds.
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If there is an increasing balance of payments problem, what happens to interest rates and bond values?
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Why would economic growth show a decline in bond values?
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What are the 9 types of risk?
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What are the negative aspects of holding cash?
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Why should investors hold some money in cash even if there are low returns?
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List the types of interest rates applied to a deposit.
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What do money market accounts offer?
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What are the types of penalties imposed on early withdrawal from money markets?
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What is the most important thing to remember about money market accounts?
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Are cash deposits risk free?
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To judge the level of ______ of your cash consider the credit worthiness of the bank and the extent that the compensation scheme will protect the deposits made.
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What judges the default risk associated with government bonds?
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What is the protection offered by the FSCS?
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How much will the FSCS cover in the event of bank failure of your deposit?
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What are some key points to remember regarding the FSCS and your cash deposits?
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How are current rates of inflation measured?
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What risk does fixed term deposits at fixed interest rates carry?
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What risks do offshore accounts carry?
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What factors should you consider when investing in foreign currency accounts?
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What are the two types of accounts available in banks and building societies?
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What are teaser rate accounts?
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What are the two types of restricted access accounts?
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What are notice accounts?
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What are term or time deposit accounts?
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What is the difference between a restricted access bank account and a structured deposit?
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What are some alternative names for a structured deposit?
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What are the usual minimum balances for a foreign currency deposit account?
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What is an advantage of an offshore sterling deposit account?
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Are ISAs/NISAs tax wrappers?
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What is the subscription limit amount on an ISA for an individual?
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What changes to ISAs are planned for April 2016?
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What are the ISA transfer rules?
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What are ISA relevant investments?
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What are the rules for 16 & 17 year olds with ISAs?
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What is a Help to Buy ISA starting December 2015?
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What are NS&I National Savings and Investments products?
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Name 4 NS&I products that are no longer available.
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Describe the NS&I Income Bond.
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What are Money Market Investments?
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Why are Money Markets important?
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What are 4 Money Market instruments?
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Describe a treasury bill.
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What are certificates of deposit?
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What are commercial bills?
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What is the most important to understand about investment vehicles?
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What are the two periods/types for money market funds?
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What criteria is used to assess whether a money market fund is suitable for a client?
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What is a typical annual charge for a money market?
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What are the risks that cash investments and money markets have in common?
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Why might a money market be less risky than a cash investment?
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What kind of instruments are bonds?
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Give some alternative names for bonds.
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More and more companies are borrowing from ____ versus their bank.
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What are the general characteristics of bonds?
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What are the 3 features of a bond title?
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What is the nominal value of a bond?
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How often do bonds pay interest?
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What is a double dated gilt and an undated gilt?
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A bond holding £10,000 refers to the ____ of the stock.
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The ____ value determines the price the stock will be redeemed by the issuer.
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Is the price quoted in the paper the price for a bond an investor would pay?
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What is the mid-market price of a bond?
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What are clean prices of a bond?
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What are the 3 bond markets?
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How often does DMO issue new gilts?
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The issue and prospective coupon are marketed to ____.
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After bond issue, subsequent trading takes place on the ____ market.
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Why is bond trading so brisk?
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What are the four major markets that make up bond trading activity?
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Study Notes
Types of Risk
- Systemic and Non-Systemic Risks: Systemic affects the entire market; Non-Systemic impacts specific sectors.
- Currency Risk: Potential loss from fluctuations in currency exchange rates.
- Interest Rate Risk: Exposure to changes in interest rates affecting asset values.
- Liquidity Risk: Difficulty in converting an asset into cash without loss.
- Counterparty Risk: Risk of the other party failing to fulfill contractual obligations.
- Regulatory Risk: Changes in laws or regulations affecting investments.
- Income Risk: Variability in income from investments or assets.
- Inflation Risk: Erosion of purchasing power due to rising prices.
- Shortfall Risk: Inability to meet financial obligations or expenses.
Negative Aspects of Holding Cash
- Cash holdings lose capital value over time due to inflation, offering little protection.
Importance of Holding Cash
- Maintaining an emergency cash reserve is crucial for financial security, even with low returns.
Types of Interest Rates on Deposits
- Includes flat, fixed or variable rates, and the implications of tax, tenure, and penalties for early withdrawal.
Money Market Accounts
- These accounts can provide higher interest rates for cash savings.
Early Withdrawal Penalties in Money Markets
- Loss of interest based on deposit size and notice periods is common for early withdrawals.
Key Consideration for Money Market Accounts
- Be mindful of notice periods and minimum balances to avoid penalties.
Cash Deposits and Associated Risks
- Cash deposits are not risk-free due to institutional creditworthiness, inflation, fluctuating interest rates, and currency exchange impacts.
Assessing Default Risk
- Evaluate the creditworthiness of financial institutions and the effectiveness of compensation schemes.
Government Bonds Default Risk Assessment
- Credit ratings from agencies like Standard & Poor's, Fitch, and Moody's signify default risk regarding government bonds and bank performance.
FSCS Protection
- The Financial Services Compensation Scheme acts as a safety net during bank failures, covering deposits.
FSCS Coverage Limit
- As of January 1, 2016, FSCS covers deposits up to £75,000, down from £85,000.
Key Points on FSCS and Deposits
- Individual limits per investor, joint account rules, recovery conditions with subsidiaries, and the time frame for cash recovery after failure.
Measuring Inflation Rates
- Different indices:
- RPI includes housing costs,
- CPI is standardized in Europe without housing costs,
- CPIH includes owner-occupied housing,
- RPIX excludes mortgage interest.
Fixed Term Deposits Risks
- Reinvestment risk arises when interest rates fall, leading to reduced returns upon maturity.
Risks Associated with Offshore Accounts
- Offshore accounts may lack protections like the FSCS, and adverse currency movements can negate higher interest benefits.
Considerations for Foreign Currency Accounts
- Key factors include market opinions on the currency, historical volatility, interest rate changes, and institutional reliability.
Types of Banking Accounts
- Instant access accounts versus restricted access accounts.
Teaser Rate Accounts
- These accounts offer higher headline interest rates with limits and may require other investments.
Restricted Access Account Types
- Includes notice accounts and term (time deposit) accounts.
Notice Accounts and Associated Risks
- Penalties for early withdrawal and potential reduced returns after an initial high rate.
Term or Time Deposit Accounts
- Fixed interest rates for 1 to 5 years with limited access to capital.
Structured Deposits vs. Restricted Access Accounts
- Structured deposits are linked to equity performance and carry inflation risk, differing from traditional restricted accounts.
Alternative Names for Structured Deposits
- Includes Guaranteed Investment Account and Deposit Plan.
Capital Protection in Structured Deposits vs. Products
- Structured deposits provide guaranteed capital from the deposit-taking firm, while structured products rely on third-party securities.
Minimum Balances for Foreign Currency Deposits
- Typically range from $10,000 to $15,000, with interests reflecting market rates.
Offshore Sterling Deposit Advantages
- Higher interest rates in tax havens with gross interest receipts.
ISA/NISA Structure
- ISAs serve as tax wrappers providing interest income tax exemptions.
ISA Subscription Limit
- £15,240 is the annual subscription limit for individual ISAs.
Upcoming ISA Changes (April 2016)
- Allowance for withdrawing and replacing funds without counting against annual limits.
ISA Transfer Rules
- No limits on transferring to cash or stocks, with allowances to change managers or transfer entire yearly amounts.
Relevant ISA Investments
- Includes bank accounts, investment funds, and certain policies meeting capital guarantees.
ISA Rules for 16 & 17 Year Olds
- Money over £100 classified as parental income until the age of 18.
Help to Buy ISA Overview
- Government bonuses for first-time homebuyers based on saved amounts, with specific conditions and limits.
NS&I Products
- Government-backed savings products purchased directly from NS&I, with variability in availability.
NS&I Product Types
- Includes Direct ISAs, Income Bonds, with others like Growth Bonds no longer available.
NS&I Income Bond Characteristics
- No capital risk, consistent interest rate, and flexible cash-out options.
Money Market Investments
- Wholesale markets for lending and borrowing among banks and governments.
Importance of Money Markets
- Provide essential capital for governments and companies, maintaining liquidity at low rates.
Money Market Instruments
- Include Certificates of Deposit, Treasury Bills, and Commercial Bills.
Treasury Bills Description
- Short-term government-issued instruments, with returns based on maturity value.
Certificates of Deposit Overview
- Issued by banks with short maturities, reflecting market-related interest rates.
Commercial Bills Definition
- Unsecured short-term instruments issued by companies to manage cash flow.
Understanding Investment Vehicles
- The composition of a portfolio is crucial to understanding investment vehicles.
Money Market Fund Types
- Short-term and longer-term funds with varied maturities.
Criteria for Money Market Fund Suitability
- Evaluation includes comparative returns, accessibility, underlying asset risks, and fund manager experience.
Typical Money Market Annual Charge
- Average charge is approximately 0.15% with no initial fees.
Common Risks in Cash Investments and Money Markets
- Shared risks: credit, inflation, and interest rate risks, varying in credit risk evaluations.
Money Markets vs. Cash Investments Risk Comparison
- Money markets typically feature lower risk due to diversified provider investments.
Bonds as Negotiable Instruments
- Bonds represent long-term debt with fixed interest, and they can be sold in the market.
Alternative Names for Bonds
- Common terminologies include stocks, debentures, and securities.
Trend of Companies Borrowing from Capital Markets
- Increasing preference among companies to borrow from capital markets over traditional banks.
General Characteristics of Bonds
- Bonds feature fixed interest rates, redemption values, and set repayment periods.
Features of a Bond Title
- Includes issuer name, interest rate (coupon), and maturity date.
Nominal Value of a Bond
- The nominal value is typically £100, distinct from market price.
Bond Interest Payment Frequency
- Bonds generally pay interest bi-annually, with variations across types.
Types of Gilts
- Double-dated gilts allow redemption between two dates; undated gilts lack a redemption date.
Nominal Value vs. Market Price
- Refers to the face value of a bond separate from its market acquisition cost.
Par Value Significance
- Determines redemption price and interest earnings at maturity.
Quoted Bond Prices vs. Market Prices
- Market prices differ from reported prices due to clean price evaluations factoring accrued interest.
Understanding Mid-Market Price
- Reflects the actual cost an investor incurs to buy a bond and the price received upon selling.
Clean Prices Explained
- Clean prices exclude accrued interest, impacting total costs for investors.
Types of Bond Markets
- Primary, secondary, and indexed bond markets signify various trading environments.
Frequency of Gilt Issues
- The DMO issues new gilts weekly, with differentiated bidding processes for large investors and individuals.
Bond Trading Bid Process
- Potential investors provide indicative bids with firm commitments due within a specified timeframe.
Leading City for Bond Trading
- London stands as the primary location for secondary bond market activities.
Factors Influencing Bond Trading Dynamics
- Investors adjust holdings based on income needs, issuer ratings, interest rate projections, and economic conditions.
Major Components of Bond Trading Activity
- Distinguished sectors: government, corporate, foreign sterling loans, and Eurobond markets.
Sterling Bonds Overview
- Refers to UK bonds sold to overseas borrowers, facilitating cross-border lending.
Eurobonds Definition
- International bonds issued in a currency that differs from the country of issuance, exemplified by UK companies issuing Euroyen bonds.
Examples of Bond Indices
- FTSE Actuaries UK Gilt Index and Barclays Capital Aggregate Bond Index represent different bond asset classes.
Understanding Bond Yields
- Yields signify the returns that bonds yield in relation to market conditions.
Commonly Reported Bond Yields
- Interest yield and redemption yield are frequently highlighted in financial outlets.
Alternative Terms for Interest Yield
- Also known as running yield, flat yield, and income yield within financial discussions.
Interest Yield Calculation Formula
- Calculated as (Coupon/Clean Price) x 100.
Misleading Nature of Interest Yield
- Can give false impressions due to potential capital gains or losses depending on purchase pricing and current market conditions.### Redemption Yield
- Redemption yield factors in income payments and capital gain or loss when holding a bond to maturity.
- Each payment's value is adjusted based on the timing of receipt, making redemption yield a thorough yield calculation.
Capital Gain or Loss
- Capital gain or loss on a bond occurs in the last year of its term.
- Income payments are received semiannually over the bond's lifetime.
Calculation Difficulty
- Calculating redemption yield typically requires a financial calculator for compound interest, which is often found in financial press.
Redemption Yield vs. Interest Yield
- A capital loss occurs if the redemption yield is lower than the interest yield when held until the redemption date.
Tax Considerations
- Redemption yield calculations ignore taxes, limiting its usefulness for average investors.
Tax-Free Bonds
- Gilt-edged and corporate bonds tend to be tax-free.
- However, income from all bonds is taxable.
Collective Fund Yields
- Fund managers provide average yield measurements based on the stocks held due to the variability of interest and lack of maturity date.
Key Risks to Bonds
- Interest rate risk
- Liquidity risk
- Inflation risk
- Currency risk
- Default risk
Interest Rate Risk
- Bond values fall when interest rates rise, particularly affecting long-term bonds which are more volatile.
Liquidity Risk
- Bonds often trade infrequently, making them difficult to sell at favorable prices.
Inflation Risk
- Inflation erodes returns; index-linked bonds can hedge against this risk.
Currency Risk
- Global bonds in portfolios introduce currency risk from fluctuating exchange rates.
Default Risk
- All bonds carry a risk that the issuer may fail to pay interest and principal at maturity.
Market Price Determination
- The yield required by investors is a key determinant of a bond's market price.
Factors Affecting Bond Prices
- Specific risks associated with the issuer and broader systemic risks affecting fixed-interest securities are major influences on bond prices.
Government Bonds Security
- Government bonds are regarded as the most secure due to the ability to raise taxes for additional funding.
Investment Grade Ratings
- The lowest investment grade ratings are BBB- (Standard & Poor's) and Baa3 (Moody's).
Non-Investment Grade Classification
- Bonds rated below BBB- & Baa3 are referred to as high yield or junk bonds.
Worst Bond Ratings
- The lowest ratings are D (S&P) and C (Moody's).
Market/Systemic Risks Examples
- Inflation, interest rates, and currency fluctuations exemplify market or systemic risks affecting bonds.
Balance of Payments Impact
- An increasing balance of payments problem leads to rising interest rates and declining bond values.
Economic Growth and Bond Values
- During economic growth, inflation and interest rates typically rise, causing a decline in bond prices.
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Description
Explore the various risks associated with different asset classes in this quiz based on RO2 Chapter 1. Understand the characteristics, systemic and non-systemic risks, as well as the implications of holding cash. Test your knowledge on how these factors impact investment strategies.