Risk Management

Correct Answer: Diversifying the portfolio by including bonds from other industry sectors to reduce concentration risk

Diversifying the portfolio by including bonds from other industry sectors is the most appropriate risk management technique for a portfolio of high-yield bonds from a volatile industry sector. High-yield bonds, also known as junk bonds, carry higher default risk compared to investment-grade bonds. By diversifying the portfolio and including bonds from other, less volatile sectors, the overall concentration risk of the portfolio can be reduced. This helps mitigate the potential impact of adverse events in the volatile sector on the entire portfolio. Selling all the bonds from the volatile sector and reinvesting in risk-free government securities would significantly reduce the portfolio's risk, but it would also limit the potential returns. High-yield bonds typically offer higher coupon rates to compensate for the increased risk, and completely avoiding them may not be the most suitable approach for investors seeking higher yields. Holding the bonds until maturity, regardless of market fluctuations, exposes the portfolio to significant credit risk. While high-yield bonds often have higher coupon rates, there is a greater possibility of default, especially in a volatile industry sector. Ignoring market signals and holding these bonds without actively managing the risk could lead to substantial losses if defaults occur.

Correct Answer: Eliminating all potential risks from the investment process

The correct answer is 'Eliminating all potential risks from the investment process'. The risk management process does not aim to eliminate all risks, but rather to identify, assess, and manage potential risks to the portfolio or investment strategy. It is not possible or desirable to eliminate all risks, as some level of risk is necessary to generate returns. The other two options, 'Identifying and assessing potential risks to the portfolio or investment strategy' and 'Developing and implementing strategies to manage and mitigate identified risks', are both key components of the risk management process according to the CFA Level 1 curriculum.

Correct Answer: Risk mitigation

Risk mitigation aims at reducing the likelihood and/or impact of a risk. Given the high impact on critical systems, the organization should use risk mitigation to reduce the potential damage malware can cause.