BEC - Risk Management Flashcards
BEC - Risk Management
Define Market Risk
The risk that a sluggish economy will affect the value of a debt instrument
BEC - Risk Management
Define Sector Risk
The risk that an event in the investment’s business sector will harm the investment
For example- the banking sector is sluggish- so even stocks of healthy banks suffer
BEC - Risk Management
Define Credit/Default Risk
The risk that a debtor will be unable to make loan payments or pay back the principal
BEC - Risk Management
Define Interest Rate Risk
The risk that a change in interest rates will adversely affect the value of the note
Example: Bond is for 10% but prevailing market rate is now 12%. If bondholder wants to sell it- they will have to sell it at a discount.
BEC - Risk Management
What does Standard Deviation measure?
It measures the volatility of an investment.
BEC - Risk Management
What is Systematic Risk?
Risk that impacts the entire market and can’t be avoided or reduced through diversification
Example: Wars
BEC - Risk Management
What is Unsystematic Risk?
Relates to a particular industry or company
Example: You own stocks in ethanol plants and an untimely freeze kills all of the corn in the Midwest
BEC - Risk Management
What does Beta measure?
Beta measures how volatile the investment is relative to the rest of the market.
In other words- how quickly (and in what amount) does the value of the stock change when the market sways?
BEC - Risk Management
What is Variance?
It compares volatility of an investment to the market average.
Factors include both Systematic and Unsystematic Risk.
BEC - Risk Management
What is a Derivative?
An asset whose value is DERIVED from the value of another asset.
Derivatives are measured at Fair Value.
BEC - Risk Management
How is an Option used?
Gives the buyer the option to buy or sell a financial derivative at a certain price
Traders use them to speculate where they think the price will be at a certain point and make a profit
Hedgers use them to offset risk
BEC - Risk Management
What is a Future?
A Forward Contract with a future value.
They are sold and traded on the futures market.
BEC - Risk Management
What is an Interest Rate Swap?
Forward Contract to swap payment agreements
They are highly liquid and often valued using the Zero-Coupon method.
Example: Steve pays Sally a fixed payment with a fixed interest rate. Sally pays Steve a variable payment tied to a benchmark such as LIBOR
BEC - Risk Management
What is Legal Risk?
Risk that a law or regulation will void the derivative
BEC - Risk Management
What is a Fair Value Hedge?
Hedge that protects against the value of an asset or liability changing.
Changes in value are reported in earnings.
