CFA Practice Question

There are 294 practice questions for this study session.

CFA Practice Question

A security will have a risk-free return if that security has ______.

I. a zero beta
II. neither systematic risk nor unsystematic risk
III. no systematic risk
IV. no unsystematic risk
Correct Answer: I, II and III

User Contributed Comments 19

User Comment
george2006 Isn't I the same as III. assuming that beta measures the systematic risk. zero beta <=> no systematic risk.

I think the problem could be more clearly stated as: " The required rate of return of a security will be risk-free rate if that security has: "

If I took the problem litterally, the correct answer should only be II. Since there is no guarantee that the zero beta asset will return the risk free rate if the unsystematic risk causes it to return otherwise.
thekapila well i beleive its not possible to have securit having no systematic risk .even the risk free asset like TReasury bonds get affected sometimes by interest rate/inflation.
tonypractice A security with a Rf return is a government bond. This security CAN have systematic risk since it can suffer from re-investment risk [if market interest rates increase , bond prices decrease...so then the investor's risk free security suddenly generates a lower yield].
not 100% sure with my thinking...
lawrence Just want to clarify several things:

1. zero beta means no systematic risk.
2. T-bill has no systematic risk. You may argue that it has interest rate risk, re-investment risk, blah blah ... you will get your investment back (principal + interest) when the T-bill matures. It has NO risk otherwise all investment theories would be invalid.
3. Non-systematic risks can be diversified away so you should not consider them at all. In other words, there is no value for non-systematic risks. You don't pay for them, you don't get any reward from them. Having non-systematic risk or not has nothing to do with risk-free risk, that's why IV is not a correct answer.
chamad I can't understand why IV is not correct meanwile the same answer is given in II (neither systematic risk nor unsystematic risk)...Can someone help?
hannovanwyk In response to lawrence, I believe you are making a mistake when you state that:
"It has NO risk otherwise all investment theories would be invalid."

1)What if the US economy collapses, then the T-bills wont mean anything. sure the chances are slim, but they are there.
2)investment theories are only valid because they are made with assumptions. And in most cases the assumptions need to be understood and are sometimes completely inrealistic
brown IV does not state that the security has no systematic risk. That's why.
Don't worry about unsystematic risk since it can be diversified.
Spawellian I have been hearing the word "SYSTEMIC" lately in work. Is that the same meaning as systematic? IE risk from the market system?
king100 I am also confused by the answer to this question. II is clearly correct (ie a risk free security has niether sytematic nor unsystematic risks - as evidenced by a standard deviation of zero. This means that logically III and IV must also be correct. If IV is incorrect, it implies that the risk free security has some unsytematic risk which is not the case.
charlie A security that has risk-free rate of return is not necessarily a risk-free security. It can still have unsystematic risks but investors don't care about these risks because they can be diversified away. That's why IV is false.

Great question!
zkhan87 don't be difficult...none of us are going to require a premium on treasury securities bc there is the slim possibility of US default. didn't happen in 30s and is not happening now.

US default = collapse of global economy = armageddon.
ybavly US default = collapse of global economy = armageddon = great songs by aerosmith
johntan1979 I don't know about you guys, but I agree with chamad. II states "NEITHER systematic NOR unsystematic risk" which means IV must be correct as well, based on my almost perfect understanding of English.
johntan1979 Unless, of course, the actual meaning of II is no systematic AND no unsystematic risk. Meaning either systematic risk alone or both must be absent to make it risk-free.

Being free of unsystematic risk (alone) does not make it a risk-free asset. Being free of systematic risk (alone) does make it a risk-free asset, as well as being BOTH free of systematic and unsystematic.

Phew... what the heck man, with all these word plays...
jonan203 i think jt1979 is right, III implies that a RF asset has no systematic risk which is true since a risk free asset wouldn't have unsystematic risk anyway; however, IV implies that while it has no unsystematic risk it may have systematic risk which a risk free asset cannot have exposure to.

III explicity states it is free of systematic risk which IMPLIES no unsystematic risk, unless you can think of an asset class (please correct me if you can think of one) that has no exposure to the movements of the market while simultaneously having volatility of its own that cannot be explained nor have any correlation with market movements.

IV has no unsystematic risk (think S&P 500 ETF or mutual fund) but complete exposure to systematic risk.
schweitzdm Thanks for your comments jt1979 and jonan203. Helps to clear up the wordplay.
sangiljin In my thought, for a risk-free asset, "no systematic risk" is required, while "no unsystematic risk" is optional.

So, I, II, III are right because they are indicating "no systematic risk". As for II, it is right because of "no systematic risk" regardless of "no unsystematic risk".

However, IV is not sufficient for a risk-free asset because it doesn't touch "no systematic risk".
sangiljin Sorry, it seems that Jonan203 is right: No systematic risk implies no unsystematic risk, but no unsystematic risk doesn't imply no systematic risk.
Anyway, total risk should be zero for a risk-free asset by definition.
maryprz14 Lawrence; amazing statement... thanks man:)
You need to log in first to add your comment.