Risk and Investment Performance Flashcards
Explain market / systematic risk and how is it measured
Affects whole of market e.g. interest rates
Non specific
Measured by Beta
Explain investment / non-systematic risk
Specific to particular company
Causes of inflation
- Rising demand fuelled by expanding money supply
- Cycles exacerbated (aggravated) by external events e.g. currency devaluation
What is deflation?
Sustained fall in prices leads to lower sales and economic output
What is stagflation?
Combination of stagnant growth and inflation
What is modified duration and how can interest rate risk be reduced?
Sensitivity of bond to move in interest rates
A bond with 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 prices rise and vice versa
Key factors that affect interest rate movements
- Economic cycle
- Government fiscal policy
- Government monetary policy
- Inflation expectations
- Preference for liquid securities
Types of risk
- Default - issuer may default on capital / interest payments
- Counterparty - counterparty to a transaction will fail
- Currency - overseas investments and companies dependent on exports
- Liquidity - unable to realise investments
- Event - issuer unable to pay interest or repay capital due to unexpected event e.g. natural disaster
- Political - new government implementing different monetary / fiscal policy
- Operational - staff errors in investment process
What is gearing?
Borrowing money to increase exposure to other assets
Magnifies positive and negative portfolio returns
