6.1 Risk and Return Concepts Flashcards
Investment risk
Rising inflation represents purchasing power risk.
A decline in a firm’s share price as a result of a 20% decline in the S&P 500 Index represents market risk.
A reduction in the value of an international stock mutual fund because of a depreciation of the Euro is an example of exchange rate risk.
The Dow Jones Utility Average has recently dropped 30% from its high, and you decide to recommend a utility sector fund to your clients. If they invest in the fund, your clients will be exposed to which of these risks?
Interest rate risk
Business risk
Financial risk
Sector funds are subject to the unsystematic (diversifiable) risks of business risk and financial risk; utility sector funds are also subject to the nondiversifiable interest rate risk because of their high debt to total capital percentage. Stocks are not subject to default risk.
Statements regarding investment risk
Rising inflation represents purchasing power risk.
A decline in a firm’s share price as a result of a 20% decline in the S&P 500 Index represents market risk.
A reduction in the value of an international stock mutual fund because of a depreciation of the Euro is an example of exchange rate risk.
Most fixed-income securities are subject to which risks
Fixed-income securities are subject to a number of risks including purchasing power, liquidity, default, and reinvestment rate risk
portfolio diversification
The answer is by increasing the number of securities in a portfolio, the total risk would be expected to fall at a decreasing rate. As more and more securities are added to a portfolio, diversification benefits begin to diminish. The main attraction of diversification is the reduction of risk without an accompanying loss of return.
Andy owns a yen-denominated bond that matures in 15 years. Andy’s bond is subject to which one of these combinations of systematic risk?
The answer is exchange rate risk and reinvestment rate risk. Because Andy owns a foreign investment, he would be subject to exchange rate risk. Also, coupon-paying bonds are subject to reinvestment rate risk.
A limited or distorted view of investment risk can result in
a portfolio containing risk that exceeds the investor’s risk tolerance level.
a portfolio that reflects extreme measures to minimize risk.
Risk
Unsystematic risk plus systematic risk equals total risk.
Systematic risk is a general risk component representing the variability of a stock’s total return as it directly relates to overall movements in the general economy.
Unsystematic risk is risk that affects only a particular company, country, or sector and its securities.
A general risk component representing the variability of a stock’s total return as it directly relates to overall movements in the general economy is known as
Systematic risk, also referred to as market risk, is the variability in a stock’s total return that is directly associated with overall movements in the general economy and cannot be eliminated through diversification.
