Risk Flashcards
Difference between systematic and non-systematic risk?
Systematic risk or market risk refers to the risk that there might be events that lead to a change in expected returns in the stock market generally. For example, global equity markets fell in the global financial crisis of 2008 and during the COVID-19 pandemic in 2020.
Non-systematic risk or investment-specific risk is the risk that there might be a change in expected returns as a result of some event or circumstance specific to a particular company or industry sector. The problems faced by BP after the Gulf of Mexico oil spill in 2010 is a good example of investment-specific risk.
What is meant by a fair return for an investor?
one that compensates the investor for the risk incurred in making the investment.
An excess return is one that over-compensates the investor for the risk incurred
What is default risk?
refers to an issuer defaulting on their obligations to pay interest and the capital on maturity. The value of a fixed-interest investment will fall when other investors decide that the probability of default has increased
What is downgrade risk?
The risk that the market anticipates that a credit rating agency is going to downgrade a bond.
When a bond is downgraded, the required return or yield rises to compensate the investor for the greater risk
What is credit spread risk?
If investors become nervous, as they did in 2008 and 2020, there is a flight to quality. This means that bonds issued by corporates will tend to underperform bonds issued by governments. This is a result of a widening of credit spreads; the difference between the yield of different grades of corporate bonds and government bonds.
What is counterparty risk?
refers to a situation in which the organisation with which an investment is placed, or the counterparty to a transaction, fails
What is bail-in risk?
Those with money in the bank may see their balance reduced, which is at odds with the basis of a bank account being 100% secure. It also has a potential impact on the compensation provided by the FSCS.
What is liquidity risk?
Forced to sell a security at a price below its fair value due to a lack of liquidity.
What is event risk?
Refers to the issuer of a security being unable to pay interest or repay capital or suffering a fall in the value of their securities due to:
- a major unexpected event (such as an industrial disaster);
- a corporate change (such as a takeover); or
- a regulatory change.
Gearing risk?
While gearing may appear attractive to clients who are targeting high returns, the high potential returns must be balanced against the higher level of risk or volatility of returns.
Interest rate risk?
risk of interest rates rising/falling and the effect this will have on bond yields
What investments might an investor consider including in their portfolio that could give some protection against inflation?
index-linked gilts
Assets that can provide long-term growth, such as equities, property, infrastructure or commodities, which have generated positive real returns over the long-term.
Currency risk?
the risk that sterling may appreciate or depreciate against the overseas currency.
Currency risk can also affect an investment in individual securities. If you invest in a company that is dependent on exporting its products and the currency where the goods are manufactured appreciates, this will affect the profitability of the company. Similarly, depreciation of a local currency will increase the cost of imports.
Political risk?
Political risk describes the risk that a new government or change in government policy will result in revised fiscal and monetary objectives, potentially including a decision to make major tax changes.
List six major risks that affect investments besides inflation risk
- interest rate risk;
- credit risk;
- currency risk;
- liquidity risk;
- event risk; and
- political risk
