CM LIC – (M8 + M8A + M9 + M9A) – Life Insurance, Investment-Linked Policies And Collective Investment Schemes Set Two

Explanation: Well-regulated governance in structured products contributes to market efficiency. Clear rules and oversight promote transparency, reduce information asymmetry, and enhance investor confidence. This, in turn, fosters a more efficient market by ensuring fair practices and facilitating informed decision-making.

Explanation: Ongoing education and awareness are crucial for investors in structured products to adapt to changing market conditions and understand new product developments. This proactive approach allows investors to stay informed about potential risks and opportunities, empowering them to make sound investment decisions beyond relying solely on financial advisors.

Explanation: Mr. Lee is exposed to Market Risk. This risk arises from the potential fluctuations in the market value of the underlying assets, in this case, the specific industry. Market risk encompasses both systematic risk, which affects the entire market, and unsystematic risk, which is specific to individual assets.

Explanation: Market risk arises from fluctuations in market conditions, impacting the overall value of assets. Unlike other risks, such as credit risk or operational risk, market risk is tied to broad market movements and affects a wide range of financial instruments.

Explanation: Mrs. Garcia’s investment would be negatively impacted by losses due to the negative performance of the technology index. Market risk, in this scenario, results from the downturn in the specific sector to which the structured product is linked.

Explanation: Diversification can help mitigate market risk by spreading investments across different asset classes. This approach helps reduce the impact of adverse movements in any single market sector, enhancing the overall stability of the investment portfolio.

Explanation: Market risk is considered inherent in structured products because these products derive their value from underlying assets, which are subject to market movements. The performance of structured products is directly influenced by changes in market conditions.

Explanation: Diversifying across a basket of global equities can decrease market risk by spreading exposure across various individual equities. This approach helps mitigate the impact of adverse movements in any single equity market, contributing to a more stable investment portfolio.

Explanation: Leverage increases market risk in structured products by magnifying both gains and losses. While it has the potential to enhance returns, it also amplifies the impact of market fluctuations, leading to increased risk exposure.

Explanation: Volatility in structured products refers to the degree of uncertainty or variation in the market price of an underlying asset. Higher volatility indicates larger price fluctuations, contributing to increased market risk.

Explanation: Investors can measure their exposure to market risk in structured products by examining the sensitivity of the product to market movements. Metrics such as delta or beta provide insights into how the structured product’s value is likely to change in response to changes in the underlying market.

Explanation: Diversifying investments across various asset classes is a precautionary measure that can help manage market risk in structured products. This approach spreads risk and reduces the impact of adverse movements in any single market sector.

Explanation: Mr. Smith’s investment could experience increased returns due to heightened demand for the commodity. The positive impact is attributed to the direct link between the structured product and the performance of the commodity market.

Explanation: Shorter maturity periods can increase market risk in structured products. This is because the potential for adverse market movements has a more immediate impact on the investment, leaving less time for market conditions to stabilize before maturity. Longer maturity periods, on the other hand, may allow for a more extended timeframe to ride out market fluctuations.

Explanation: “Issuer or Swap Counterparty Credit Risk” refers to the risk of default by the entity issuing the structured product or acting as a swap counterparty. This risk arises when the issuer or counterparty fails to meet its financial obligations, potentially leading to losses for the investor.

Explanation: Mr. Turner should carefully assess the creditworthiness and financial stability of the issuing entity to manage Issuer or Swap Counterparty Credit Risk. Knowing the financial strength of the issuer helps investors gauge the likelihood of default and make informed investment decisions.

Explanation: A lower credit rating increases credit risk. A lower credit rating indicates a higher probability of default by the issuer or swap counterparty, leading to increased credit risk for the structured product.

Explanation: Diversification reduces reliance on a single issuer or swap counterparty, thereby managing Issuer or Swap Counterparty Credit Risk. Spreading investments across multiple issuers helps mitigate the impact of default by a particular entity.

Explanation: The primary concern for investors when evaluating Issuer or Swap Counterparty Credit Risk is the timely payment of principal and interest by the issuer or swap counterparty. This risk revolves around the potential default of the entity responsible for meeting its financial obligations.

Explanation: The structured product linked to the start-up company’s bond has higher credit risk. Start-ups generally have a higher risk of default compared to well-established companies, impacting the credit risk associated with the structured product.

Explanation: The use of credit default swaps (CDS) can mitigate Issuer or Swap Counterparty Credit Risk by transferring it to a third party. CDS act as insurance, providing protection to investors against the default of the issuer or swap counterparty.

Explanation: Collateralization decreases credit risk by providing additional security. When a structured product is collateralized, there are assets set aside as collateral to cover potential losses in case of default by the issuer or swap counterparty, reducing the overall credit risk.

Explanation: Investors can monitor changes in Issuer or Swap Counterparty Credit Risk over time by analyzing historical performance. Examining how the issuer or swap counterparty has managed credit obligations in the past provides insights into their financial stability and creditworthiness.

Explanation: The government-issued structured product generally has lower credit risk compared to one issued by a private corporation. Governments are often considered more creditworthy, reducing the likelihood of default.

Explanation: Staying informed about the financial health and creditworthiness of the issuer or swap counterparty is crucial for making informed investment decisions and managing credit risk. This knowledge helps investors assess the likelihood of default and potential impacts on the structured product’s performance.

Explanation: Complexity increases credit risk. In general, more complex structured products may involve intricate financial arrangements, making it challenging to assess the issuer or swap counterparty’s ability to meet its obligations. Simpler structures often offer greater transparency and ease of evaluation.

Explanation: “Liquidity Risk” refers to the risk of not being able to buy or sell the structured product at prevailing market prices. This risk arises when there is limited market activity or a lack of willing buyers or sellers, potentially leading to adverse impacts on the transaction’s execution.

Explanation: Smaller market size increases Liquidity Risk. In smaller markets, there may be fewer participants, reducing the number of potential buyers or sellers. This can result in wider bid-ask spreads and challenges in executing transactions, contributing to increased Liquidity Risk.

Explanation: Mr. Anderson might face difficulty finding a buyer, potentially selling at a price significantly below market value. Limited trading activity in the market can result in fewer buyers, making it challenging to execute the sale at the desired price and increasing the impact of Liquidity Risk.

Explanation: Complexity increases Liquidity Risk. More complex structured products may have a smaller pool of potential buyers or sellers due to the specialized knowledge required for understanding and trading them. This complexity can hinder market participation, contributing to increased Liquidity Risk.