Risk And Investment Performance Flashcards
Market / Systematic risk
Non specific
Measured by Beta
Investment/non - systematic risk
Specific to a particular company
Inflation risk
Cost of goods & services - some prices tend to increase more rapidly than inflation
Deposit based investments & fixed interest are hardest hit by inflation
Real Asset protection - values generally move in line with inflation (liquidity can drive values)
Causes of inflation
Rising demand fuelled by expanding money supply
Cycles inflated by external events e.g., currency devaluation
Deflation
Sustained fall in prices leads to lower sales and economic output
Stagflation
Combination of stagnant growth and inflation
Interest rate risk
Important for fixed income or floating/variable rate securities
Modified duration - sensitivity of a bond to a move in interest rates
A bond with a duration of 2 will move by about 2% when interest rates move by 1% in opposite direction
Interest rate risk is reduced by reducing the duration of the portfolio
If interest rates fall bond values rise and vice versa
Key factors of Interest Rate Moves
Economic cycle
Government fiscal policy
Government monetary policy
Inflation expectations
Preference for liquid securities
Credit risk
Default: risk that issuer may default on interest/capital
Downgrade: anticipation of a credit agency downgrade
Credit spread flight to quality
Currency risk
Overseas investments and companies
dependent on exports
Liquidity risk
When forced to sell at price below fair
value:
Private equity & property particularly
illiquid
Event risk
Issuer being unable to pay interest or
repay capital due to unexpected event e.g.,natural disaster
Political risk
New/changed government implementing different fiscal or monetary policy
Operational risk
In investment process e.g., staff errors, fraud, or settlement risk
Net present value
Present value of all the cash flows
Represents the costs/cash received from an investment
Positive NPV - investment is attractive
Negative NPV - investment is unattractive
