Chapter 7 - Investment Risk Flashcards
Types of Risk
Systematic Risk - Market Risk
Unsystematic Risk - Business, Management, Financial, Industry
Liquidity Risk - e.g. property, bonds
Inflation Risk - re purchasing power. Affects pensioners more. Cash, fixed income. Gold is good for long term.
Interest Rate Risk - Affects most investments, affect capital and income
Gearing Risk - borrow to increase exposure to other assets. Magnifies + and - returns. Hedge funds. High risk.
Currency Risk - 70% of UK FTSE 100 companies earnings come from overseas.
Credit Risk - Bonds or deposits with financial institutions.
Default risk, Downgrade risk, Credit spread risk, Counterparty risk.
Bail-in Risk - financial assistance comes from existing capital base, e.g. shareholders, bondholders, depositors,.
E.G. Cyprus, some depositors had to write off own holdings. Might be used in future in UK, not bail out by government.
Political Risk - changes in government or policy.
Volatility Risk
If 2 shares have same expected return, take the one with lower volatility.
Measured by standard deviation (sigma sign).
Difference between actual return and expected return
Square the difference
Multiply the difference squared by the probability
Add all results. This sum will be the variance.
Take the square root. This is standard deviation.
Low SD = lower risk
Higher SD = higher risk
Correlation
How two investments move in relation to each other.
Values between -1 and +1.
Perfect positive is +1. Same values = no diversification benefit.
Perfect negative is -1. Great diversification benefits.
Zero correlation is where returns show no correlation and move randomly re the other.
