Risk Management Flashcards

1
Q

Define Market Risk

A

The risk that a sluggish economy will affect the value of a debt instrument

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2
Q

Define Sector Risk

A

The risk that an event in the investment’s business sector will harm the investment

For example- the banking sector is sluggish- so even stocks of healthy banks suffer

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3
Q

Define Credit/Default Risk

A

The risk that a debtor will be unable to make loan payments or pay back the principal

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4
Q

Define Interest Rate Risk

A

The risk that a change in interest rates will adversely affect the value of the note

Example: Bond is for 10% but prevailing market rate is now 12%. If bondholder wants to sell it- they will have to sell it at a discount.

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5
Q

What does Standard Deviation measure?

A

It measures the volatility of an investment.

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6
Q

What is Systematic Risk?

A

Risk that impacts the entire market and can’t be avoided or reduced through diversification

Example: Wars

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7
Q

What is Unsystematic Risk?

A

Relates to a particular industry or company

Example: You own stocks in ethanol plants and an untimely freeze kills all of the corn in the Midwest

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8
Q

What does Beta measure?

A

Beta measures how volatile the investment is relative to the rest of the market.

In other words- how quickly (and in what amount) does the value of the stock change when the market sways?

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9
Q

What is Variance?

A

It compares volatility of an investment to the market average.

Factors include both Systematic and Unsystematic Risk.

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10
Q

What is a Derivative?

A

An asset whose value is DERIVED from the value of another asset.

Derivatives are measured at Fair Value.

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11
Q

How is an Option used?

A

Gives the buyer the option to buy or sell a financial derivative at a certain price

Traders use them to speculate where they think the price will be at a certain point and make a profit

Hedgers use them to offset risk

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12
Q

What is a Future?

A

A Forward Contract with a future value.

They are sold and traded on the futures market.

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13
Q

What is an Interest Rate Swap?

A

Forward Contract to swap payment agreements

They are highly liquid and often valued using the Zero-Coupon method.

Example: Steve pays Sally a fixed payment with a fixed interest rate. Sally pays Steve a variable payment tied to a benchmark such as LIBOR

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14
Q

What is Legal Risk?

A

Risk that a law or regulation will void the derivative

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15
Q

What is a Fair Value Hedge?

A

Hedge that protects against the value of an asset or liability changing.

Changes in value are reported in earnings.

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16
Q

What is a Cash Flow Hedge?

A

A hedge that protects against a set of future cash flows changing.

Changes in value are reported in OCI.

17
Q

What is a Foreign Currency Hedge?

A

A hedge that protects against the value of a foreign currency changing.

For example- a foreign currency hedge might be used to protect against the following: If you have receivables denominated in a foreign currency and that currency dips in value - your receivables are worth less than before.

18
Q

The Treynor index is based on the premise that there are two components of risk

A
  1. Risk produced by fluctuations in the market

2. Risk produced by fluctuations of the individual stock

19
Q

The drum-buffer-rope theory

A
  • Assumes that within a manufacturing system there is at least one (or a limited number) of constraints created by scarce resources.
  • States that in order to best protect the throughput of a manufacturing operation, the limiting factor of the manufacturing process must be protected.
  • States that it is important to protect against inflationary inventory levels (inventory build ups) and the associated carrying costs which can occur at bottlenecks (constraints).
  • Focuses on only the queuing area within a manufacturing firm that is in front of the constraint (bottleneck).
20
Q

What is Kanban technique

A

is a technique for managing a just-in-time inventory system. The kanban is a tag attached to the storage container where component parts are kept. As a component is used, a kanban is placed in a box. Managers determine the number of kanbans needed to be in the box of the component part before a reorder of that part is necessary.

21
Q

weak-form market efficiency

A

suggests that information about past prices would not be of use in predicting future performance

22
Q

semi-strong market efficiency

A

suggest that all publicly available information is incorporated in market prices

23
Q

strong-form efficient markets

A

suggest that all available information is incorporated in current market prices

24
Q

What is a failed-soft protection?

A

It is an advantage of distributed systems.

Allows for the capability to continue processing at all sites except a nonfunctioning one

25
Q

Poison put clause

A

It is a covenant that obliges the borrower to repay the bonds if a large quantity of common stock is held by a single investor and the bond rating is downgraded. This type of bond covenant is used as a defensive strategy to prevent hostile takeovers.

26
Q

Certainty equivalent adjustments

A

is a risk analysis technique that is based upon utility theory. The “utility” is how much a certain sum of money is worth to the investor. It makes the decision maker stipulate at what point he or she is indifferent to the choice between a certain amount of money and the expected value of a risky amount.