SIE Exam Unit 6 Flashcards
6: Systematic Risk
The risk that changes in the overall economy will have an adverse effect on individual securities, regardless of company’s circumstances. Portfolios will always be subject to systematic risk.
6: Nonsystematic risk
Risks can be reduced through diversification. Unique to a specific industry, business enterprise, or investment type.
Beta measures volatility of an asset (S&P 500 beta of 1). Beta>1=more volatile than market.
6: Nonsystematic risks
Default Risk, business risk, financial risk, call risk, prepayment rick, currency risk, liquidity risk, regulatory risk, legislative risk, political risk, sovereign risk.
6: Default Risk
Nonsystematic: Potential to lose some or all of money. Capital risk is risk that investor won’t get all money back. Minimal to none when investing in securities backed by Fed (T-Bills).
6: Business Risk
Nonsystematic: Operating risk, poor management decisions.
6: Financial Risk
Nonsystematic: Companies using debt financing (leverage). Inability to meet interest and principal payments on those debt obligations could lead to bankruptcy (credit or default risk).
6: Call Risk
Nonsystematic: risk that bond might be called before maturity and investor unable to reinvest principal at a comparable rate of return. Can lead to reinvestment risk (systematic). Look for call protection when interest rates falling and bonds with higher coupon rates will be called.
6: Prepayment Risk
Nonsystematic: Risk that borrower will repay principal before maturity and deprive lender of future interest payments. Risk associated with call risk. GNMAs subject to prepayment risk because underlying mortgages may be refinanced when interest rates fall.
6: Currency Risk
Nonsystematic: decline in currency when investing in foreign securities. Currency quoted at spot rate (current MV).
6: Liquidity Risk
Nonsystematic: investor might not be able to sell an investment quickly at fair market price aka marketability risk.
6: Regulatory Risk
Sudden change in regulatory climate may have dramatic effect on performance of a business or entire business sectors. (EPA, FDA etc)
6: Legislative Risk
Nonsystematic: Change in law (not regulations) from government. Ex: luxury tax on higher-priced items such as cars and boats.
6: Political Risk
Nonsystematic: relates to political instability, particularly true in emerging economies.
6: Sovereign Risk
Nonsystematic: Capture risk of a country defaulting on commercial debt obligations
6: Mitigating Systematic Risk
Risk built into the system, only way to mitigate is to find an asset that will move in the opposite direction of markets as a whole. Can use derivatives to hedge portfolio risk.
