Ch 6 Flashcards
What is systematic/market risk?
Might be a reduction in expected returns as a result of a fall in the stock market generally
What is non-systematic/investment-specific risk?
Risk of a single financial institution defaulting or reduction in expected returns of particular company/sector
What is systematic risk measured by?
Beta
What is the Gov’s target for inflation? What is it measured by?
2%
CPI
What is CPI used for?
- Gov’s inflation target
- Increasing benefits/state pension
What is CPIH?
CPI including costs of owning, maintaining and living in your own home
What is RPI still used for?
Contracts such as pension increases and index-linked gilts
How is the inflation rate calculated?
Change in prices of over 700 separate separate goods and services
In the shorter term, what does inflation cause?
Uncertainty and the potential for Gov’s to introduce restrictive policies
What asset classes are hardest hit by inflation and why?
Cash deposits & fixed interest securities
Erodes real value of capital
What causes inflation?
Can be caused by many factors, historically this was thought to be supply and demand.
Investor sentiment can also contribute.
What is deflation?
Sustained fall in prices
How can rising demand cause inflation?
- Bottlenecks in production cause prices to rise/imports to flood in
- Gov increases interest rates to control
- Cuts in public expenditure
- Economy enters recession and prices steady or fall,
Why is deflation bad for an economy?
Consumers delay spending in order to pay lower prices which leads to lower sales/lower economic output
What is stagflation?
Combination of stagnant growth and inflation
When interest rates rise, what happens to the value of fixed interest securities?
They fall
When interest rates fall, what happens to the value of fixed interest securities?
They rise
How is interest rate risk measured?
Duration
What is modified duration?
Measure of sensitivity of a bond/bond portfolio to a move in interest rates.
For eg if interest rates move 1%, and a bond has a duration of 5, it will move 5%
What are the 5 key factors of interest rate movements?
- Economic cycle
- Government fiscal policy
- Government monetary policy
- Inflation expectations
- Preference for liquid securities
What are the different types of credit risk?
- Default risk
- Downgrade risk
- Credit spread risk
- Counterparty risk
What is currency risk?
Where an investment is made overseas by UK-based investor, risk that Sterling will appreciate against the overseas currency
Can also affect companies that rely on exports/imports
What is liquidity risk?
Risk of having to sell security at a price below its fair value due to lack of liquidity
What is event risk?
Risk of the issuer of a security being unable to pay interest or repay capital due to a major unexpected event (such as industrial disaster), a corporate change (such as a takeover) or regulatory change
Also includes natural catastrophes inc earthquakes, floods etc
