Types of Risk

Question 1

Market Risk

Answer 1

Systematic Risk
investment decline in value due to economic development/events in entire markets / sector
Ex: Recession or war
Equity Risk = Investment in shares (Share Value)
IR Risk = debt investment (Bond Market Value - Price)
Currency Risk = own foreign investment (movement in exchange Rate)

Question 2

Credit Risk

Answer 2

Default Risk
Risk that government/firms (issuer) will have in case of financial difficulties
Won´t pay coupons (interest) or principal
Evaluation of credit risk (risk of default) by ratin agencies (government vs corporation & investment grades)

Question 3

Reinvestment Risk

Answer 3

Risk of loss from reinvesting principal or income at lower IR
Ex: bonds mature and you will have to reinvest it at lower rate (sell at lower price) –> related to forwards

Question 4

Liquidity Risk

Answer 4

Risk of being unable to sell investment at fair price
or when you want it (due to few participants)
won´t find counterparty who is willing to trade spec. investment
affects duration & maturity
E.x OTC Market

Question 5

Systemic Risk

Answer 5

less defines - specific to firms
narrow problems (e.g problems in payment system or economic crisis triggered by failure of financial system)
Risk cause at firm level that is severe enough to cause instability in whole financial system
E.g. Collapse of Lehman Brothers

Question 6

Basis Risk

Answer 6

Risk coming from hedging strategy
offsetting investment won´t experience price change entirely opposite direction from each other
imperfect correlation - potential excess from gain/loss to hedging strategy
(thus adding risk to position instead minimising)

Question 7

Others

Answer 7

Concentration Risk
Counter-party Risk (OTC)
Settlement Risk (decide not to trade)
Inflation Risk

Question 8

HEDGING

Answer 8

only worry about Risk
Risk Averse - Minimise Risk as possible
company focus on that which they are good
prepare to pay money to transfer uncertainty/risk to someone else

Question 9

SPECUALTE

Answer 9

Risk/Return
Take Risk in expect of Reward
many market participants are willing to take uncertainty in return for money

Question 10

ARBITRAGE

Answer 10

Reward without Risk
taking advantage of inefficiency/dislocation in the market
trying to break the risk/reward equality

Question 11

Risk

Answer 11

probability of known outcome
manageable
quantifiable

Question 12

Uncertainty

Answer 12

all about making assumptions
uncontrollable
FM is based on uncertainty