Canadian Securities Course (CSC) Level 2 Practice Exam

Which risk type is associated with the effects of inflation on returns?

1. Interest rate risk

2. Liquidity risk

3. Foreign investment risk

4. Real rate of return risk

The correct answer is: Real rate of return risk

The correct choice is indeed related to the impact of inflation on investment returns, and it specifically pertains to how inflation erodes the purchasing power of future cash flows. As inflation rises, the real rate of return on investments, which is the nominal return adjusted for inflation, can diminish. This means that even if an investment appears to yield a significant nominal return, its actual value can be substantially less in terms of purchasing power due to inflation. The other types of risks mentioned do not connect in the same way to inflation: - Interest rate risk refers to the potential for investment losses due to changes in interest rates, which primarily affects the value of fixed-income investments. - Liquidity risk relates to the ease with which an asset can be converted to cash without significantly affecting its price. While this can impact investor returns, it does not directly correlate with inflation. - Foreign investment risk involves uncertainties and potential losses associated with investing in foreign assets, including currency fluctuations or political instability, rather than the effects of inflation on returns. Thus, real rate of return risk is the most accurate choice regarding the impact inflation has on investment returns.