Association for Financial Professionals (AFP) Practice Exam

Which risk is associated with purchasing asset-backed commercial paper (ABCP) denominated in a foreign currency?

1. Liquidity risk only

2. Price risk only

3. Liquidity and foreign exchange risk

4. Credit risk only

The correct answer is: Liquidity and foreign exchange risk

Purchasing asset-backed commercial paper (ABCP) that is denominated in a foreign currency introduces both liquidity risk and foreign exchange risk. Liquidity risk arises because ABCP is typically a short-term investment, and if market conditions change or if there are any issues with the underlying assets, the ability to sell or rollover the investment can be severely impacted, especially in foreign markets where liquidity may be less favorable. Foreign exchange risk is critical when dealing with assets in a foreign currency. Fluctuations in exchange rates can affect the value of the ABCP when it is converted back to the investor's home currency. If the foreign currency weakens against the investor's domestic currency, the investment could yield a lower return or even a loss when the ABCP matures, even if the underlying assets performed well. Therefore, the combination of these two risks is significant when investing in ABCP denominated in foreign currency, making the correct answer that both liquidity risk and foreign exchange risk are involved in such an investment.