CFA Practice Question

There are 139 practice questions for this study session.

CFA Practice Question

The high variability of returns on individual venture capital investments is primarily due to:

I. unique event risk.
II. systematic risk.
Correct Answer: I only

There is a high level of company-specific risk in individual venture capital investments.

User Contributed Comments 6

User Comment
jpducros Why about II ?
cbeliveau I am guessing II is not right because systematic risk is inherent to the industry and therefore it affects all investments equally in the industry not just for venture capital investments.
johntan1979 The explanation given in the answer for II is the perfect definition of UNsystematic risk.

Answer should be I and II.
johntan1979 Unsystematic risk that exist in individual venture capital investments can be diversified, and hence, the risk will be reduced, lowering volatility.

On the other hand, systematic risk cannot be reduced through diversification. But why the answer is I only is because systematic risk don't exist in INDIVIDUAL venture capital investments.

So the final verdict is, the answer I only is correct.
ascruggs92 Johntan1979, you are a legend in the analyst notes comment section and just about always on point. However you're reasoning here is incorrect.

Simply put, all investments - public, private, equity, debt, etc. - are exposed to systematic risk that cannot be diversified away. Some assets are more sensitive to systematic risk than other (what beta attempts to measure), and it does make sense that VC investments would be more sensitive to systematic risk due to their unproven nature.

However, the question asks for the PRIMARY reason. Returns are highly variable on individual VC investments because they are typically unique, unproven companies that will boom or bust, and events unique to their situation are either more supportive or more detrimental their success.

A good example is MySpace. Had MySpace been a public company, their stock would suffer along with everyone else's in a bear market. However, when Facebook came along, MySpace didn't just lose market share, it became an afterthought. In a matter of two years or so MySpace went from a pioneer in social media to an almost worthless company. That, my friends, is unique event risk.
jagp The key word here is PRIMARILY
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