Risk

Question 1

What are systemic and non-systemic risks?

Answer 1

1. Systemic - the risk of disruption to the financial system triggered by an event such
   as an economic shock or institutional failure.
2. Non-systemic - the risk of a single financial institution defaulting.

Question 2

Name the Capital Risks (4)

Answer 2

1. Credit Risk
2. Liquidity Risk
3. Event Risk
4. Gearing Risk

Question 3

Name and Explain the types of credit risk (5)

Answer 3

1. Default Risk - issuer defaulting on ability to pay
2. Downgrade risk - market anticipates that a credit rating agency is going to downgrade a bond.
3. Credit Spread Risk - investors become nervous due to a widening of the yields between corp. and govt. bonds.
4. Counterparty risk - the organisation with which an investment is placed, or the counterparty to a transaction fails.
5. Bail-in Risk - risk of banks having to be bailed out.

Question 4

Explain Liquidity Risk

Answer 4

The risk investors are forced to sell at a price below its fair value due to lack of liquidity.

Question 5

Explain Event Risk

Answer 5

The inability of an issuer to pay due to an event

Question 6

Explain Gearing Risk

Answer 6

The risk of borrowing money to increase exposure to magnify positive and negative returns

Question 7

Explain the income Risks (4)

Answer 7

1. Cash Deposit Risk - variable interest rates effect income
2. Bond Income - Returns are fixed and will be eroded by inflation and increasing interest rates
3. Dividend Income Risk - Dividend rates can fluctuate
4. Property Income Risk - Risk that the tenant defaults or rents lowering

Question 8

Explain interest rate risk

Answer 8

1. When interest rates rise, the value of fixed interest investments fall
2. When interest rates fall, the value of fixed interest investment rise

Question 9

How is interest rate risk measured

Answer 9

1. In terms of duration - this is the sensitivity
2. Longer maturity/lower coupon - longer duration - more volatile
3. Shorter duration/higher coupon - shorter duration - less volatile

Question 10

Explain Inflation risk

Answer 10

The risk that inflation eats into real returns

Question 11

Explain Currency Risk

Answer 11

the risk that sterling may appreciate or depreciate against the overseas currency

Question 12

Explain Political Risk

Answer 12

the risk that a new government or change in government policy will result in changes to monetary and fiscal policy

Question 13

Explain Regulatory Risk

Answer 13

the risk that inadequacy or changes to regulation effect the value of investments

Question 14

Explain Operational Risk

Answer 14

risk that can arise from the investment process

Question 15

Explain Shortfall Risk

Answer 15

the risk that an investor might not achieve their specific financial target