Risk Flashcards
Market/Systematic Risk
risk that the stock market in general may fall
Investment-specific/Non-systematic Risk
risk that a particular event/circumstance will affect a particular company
Inflation Risk
Negative real returns
Interest Rate Risk
Rise and fall of interest rates
Rising rates, bad for those in fixed term investments
Falling rates make variable accounts less attractive
Political risk
Changing government may introduce new rules/regulations
Taxation risk
Risk that regulations on tax may change in the future
4 Types of Credit Risk
Credit risk = risk of financial stability deteriorating of a company
- Default - risk of company defaulting
- Downgrade - credit agency downgrading
- Counterparty - counterparty to contract won’t pay what it promised to
- Bail-in risk- shareholders/depositers called upon to front cash
Currency risk
Risk of investing abroad, fluctuations in currencies
Liquidity Risk
Maybe forced to sell at lower value
Cannot sell
Diversification
Most important strategy for reducing risk
- Reduces risk of relying on one particular investment
- Avoids over-exposure to single asset class
- protects against inflation
- spreads opportunity for potential returns
- invest in uncorrelated assets for minimal risk/volatility
- possibility of stable returns through all economic cycle
- regular rebalancing = stays in line with ATR over time
Pound cost averaging - reduces risk because
regular contributions lessen the chance of investing at the very top of the market or just before a significant fall
Risk Premium
difference in the rate of return between an investment involving risk and a risk free investment
This is the amount that investors require above the rate that they can obtain in a safe investment in order to persuade them to invest in a riskier one
Risk profiling
What risk means to a particular investor
What would be the most worrying outcome from an investment re specific goal
Level of losses can tolerate
Risk Assessment Process - two main aspects of client’s position
Client’s aims and the resources available to meet those aims
Client’s objectives and subjective ability to tolerate losses
Important to review ATR regularly
- Attitudes and tolerance to risk may change over time with experience/knowledge
- Objectives may change over time, timeframes, income/growth etc
- Capacity for loss may be very low and therefore even if had higher ATR it wouldn’t be suitable
- ATR differs for different objectives
- Changed based on personal circumstances/health
- Changes based on income/inheritance
- Changes as a person gets older/timeframe
- Children’s needs may change so ATR may need adjusting
- Fund performance/market performance/to ensure investments match ATR
- How much risk do you need to take? How much can afford to take? What if target is achieved?
