06. Risk

Question 1

What is systematic (aka market) risk?

Answer 1

The risk that there might be events that lead to a change in expected returns in the stock market generally. E.g. Covid.

Question 2

What is non-systematic (aka investment-specific) risk?

Answer 2

The risk that there might be a change in expected returns as a result of some event or circumstance specific to a particular company or industry sector. E.g. BP oil spill.

Question 3

What is systemic risk?

Answer 3

Broader. The risk of disruption to the financial system triggered by an event such as an economic shock or institutional failure that causes a chain reaction leading to price volatility, significant losses or market failure. E.g. a run on a bank.

Question 4

What is non-systemic risk?

Answer 4

The risk of a single financial institution defaulting.

Question 5

What is default risk?

Answer 5

The risk of an issuer defaulting on their obligations to pay interest and the capital on maturity.

Question 6

What is downgrade risk?

Answer 6

The risk that the market anticipates that a credit rating agency is going to downgrade a bond.

Question 7

What is credit spread risk?

Answer 7

When investors get nervous and there is a flight to quality which results in a widening of credit spreads, the difference between yields of corporate & government bonds.

Question 8

What is counterparty risk?

Answer 8

The risk of the organisation with which an investment is placed, or the counterparty to a transaction, fails.

Question 9

What is bail-in risk?

Answer 9

The risk of governments and/or central banks having to bail out financial institutions in difficulty.

Question 10

What is liquidity risk?

Answer 10

The risk faced by investors when they are forced to sell a security at a price below its fair value due to a lack of liquidity.

Question 11

What is event risk?

Answer 11

Similar to default risk. It is the risk of the issuer of a security being unable to pay interest or repay capital or suffering a fall in the value of their securities due to a specific event.

Question 12

Name 3 events that could happen under event risk.

Answer 12

1. Extreme act of nature e.g. flood.
2. Corporate change e.g. takeover.
3. Regulatory change.

Question 13

What is gearing?

Answer 13

Gearing or leverage is borrowing money to invest in other assets.

Question 14

What is duration?

Answer 14

The measurement of interest rate risk.

Question 15

What is modified duration?

Answer 15

The measure of the sensitivity of a bond or bond portfolio to a move in interest rates.

Question 16

What is operational risk?

Answer 16

The operational risk that can arise from the investment process.

Question 17

What is shortfall risk?

Answer 17

The risk that an investor might not achieve their specific financial target when saving or investing money.