Free CSI CSC2 Practice Exam with Questions & Answers

Specific risk, also called unsystematic or diversifiable risk, is the risk associated with individual companies or industries. It includes risks such as poor management decisions, product failures, labour disruptions, litigation, or company-specific earnings weakness. By holding a broadly diversified portfolio such as all stocks in the S & P/TSX Composite Index, an investor can theoretically diversify away company-specific risk because negative events affecting one company may be offset by performance from others. Systematic risk cannot be eliminated through diversification because it affects the whole market, such as interest rate changes, recessions, inflation shocks, or broad market declines. Default risk is more directly associated with credit instruments. Therefore, the risk theoretically eliminated through broad equity diversification is specific risk.

Index mutual funds are structured to replicate the performance of a market index, such as the S & P/TSX Composite Index. Since these funds do not require active management, their management fees are among the lowest compared to other types of mutual funds. Active management in asset allocation, small-cap, or bond funds involves more frequent trading and research, increasing operational costs.

One of the most significant factors limiting the effectiveness of fiscal policy is the time lag involved in implementing tax changes or expenditure adjustments. This lag exists because fiscal policy measures typically require parliamentary approval and detailed legislative processes, delaying their impact on the economy.

Types of Fiscal Policy Lags

Recognition Lag: Time taken to recognize the need for intervention.

Decision Lag: Time taken by policymakers to design and approve a fiscal response.

Implementation Lag: Time taken for the effects of the fiscal measures to manifest in the economy​​.

Other Options Considered:

Level of Tax Rates (A): While high tax rates may reduce economic activity, they do not inherently limit fiscal policy effectiveness.

Level of Inflation (B): Inflation primarily impacts monetary policy rather than fiscal policy directly.

Short-Term Interest Rates (C): These are more relevant to monetary policy, which is managed separately by the central bank​​.

Illustrative Case: In scenarios requiring rapid economic intervention (e.g., recessions), these lags often mean fiscal responses are delayed, sometimes reducing their relevance or efficiency by the time they are implemented​.

Mortgage-Backed Securities (MBS) are designed to address prepayment risk , which arises when borrowers pay off their mortgages earlier than expected. Prepayments reduce the interest income investors receive and can affect the expected return on the security.

Why Prepayment Risk is Addressed :

Prepayment often occurs when interest rates decline, as borrowers refinance their mortgages. This leaves MBS investors reinvesting at lower yields, which impacts returns.

Structuring MBS helps mitigate prepayment risk through mechanisms like tranches in Collateralized Mortgage Obligations (CMOs).

Explanation of Options :

A. Liquidity : Incorrect. MBS provides liquidity to lenders but is not designed to address liquidity risk directly.

B. Interest Rate : Incorrect. MBS investors are still exposed to interest rate risk as rates impact prepayment behavior.

C. Rollover : Incorrect. Rollover risk applies to short-term debt securities, not MBS.

D. Prepayment : Correct. MBS structures are specifically designed to mitigate the impact of prepayments on investors.

A business trust typically acquires the operating assets of businesses such as restaurants , which generate predictable and steady cash flows. Business trusts focus on distributing income to unitholders, and restaurant operations align well with this goal due to their recurring revenue models.

Explanation of Options :

A. Senior Housing : More common for real estate investment trusts (REITs), not business trusts.

B. Restaurants : Correct. Restaurants are suitable for business trusts because of their stable cash flow potential.

C. Industrial Rentals : Typically under REITs, not business trusts.

D. Shopping Centres : Also more commonly associated with REITs.