Chapter 5: The nature and impact of the main types of risk on investment performance

Question 1

What is systematic (or market) risk?

Answer 1

*Risk that exists over the entire market such as world events (9/11 & the Covid pandemic).
*Cannot be removed with diversification
*Benchmarked by beta (1)

Question 2

What is non-systematic risk?

Answer 2

Risk that exists within companies and investments, this can be removed with diversification.

Question 3

What is inflation risk?

Answer 3

Risk that rises in the price of goods and services will outperform investment gains

Question 4

What is the official measure of inflation?

Answer 4

Consumer price index (CPI)

Question 5

What would a 2.6% annual CPI rate mean?

Answer 5

£100 worth of shopping in March 2024 would cost £102.60 in March 2025

Question 6

Rank these in order of risk, highest to lowest:

1. Property, Listed equities, Junk bonds
2. Banks, Gilts, NS&I, Index linked GILTS, cash
3. VCT’s, Deriatives, EIS, Unlisted shares
4. Corporate bonds, collectives, life assurance polices

Answer 6

3
1
4
2

Question 7

What is the most important strategy to reduce risk?

Answer 7

Diversification, will reduce unsystematic risk

Question 8

What is gearing?

Answer 8

Where investors borrow money to purchase investments that increase exposure to other assets, such as equities

Question 9

Which asset classes offer the best chance of beating inflation?

Answer 9

Property and equities, they also carry the highest risks of the 4 asset classes

Question 10

How is interest rate risk measured?

Answer 10

By duration, the higher the duration, the more sensitive it will be to change.

If interest rises by 0.25%, a bond with a duration of 4 will drop 1%

Question 11

What is shortfall risk?

Answer 11

Risk that an investment underperforms, causing you to fail to reach a target amount