Unit 11: Types of Investment Risk Flashcards
What is systematic risk?
the risk associated with the macroeconomic factors. (changes in the overall economy will have an adverse effect on security regardless of company’s circumstances. non-diversifiable risk)
ex. war, inflation, global security threats
What are the 4 main types of investment risk?
- Systematic risk
- Unsystematic risk
- Opportunity Cost
- Liquidity Priority
What is unsystematic risk?
risk unique to specific industry or business enterprise (diversifiable risk)
ex. labor strikes, lawsuits, product failure
What are the 4 main types of non-diversifiable (systematic) risk?
1.market risk
2. interest rate risk
3. Reinvestment risk
4. inflation risk
What is market risk?
Risk of market changes, measured by beta correlation
What is interest rate risk?
market risk for bonds , debut securities, preferred stock
What is reinvestment risk?
The market is different when cash is paid out, can’t reinvest income at same rate
What is inflation risk?
AKA purchasing power risk
fixed income securities - cash value changes as inflation changes
What is Opportunity Cost risk?
Represents the return given up on an alternative investment
highest valued alternative that must be sacrificed as a result of choosing among alternatives
Risk free alternative: US Treasury bonds
Any return that deviates from the risk free alternative represents your opportunity gained or lost
What is Liquidity Priority Risk?
Debt always has priority over equity:
1. Secured Creditors (mortgage bonds, equipment trust certs., collateral trust bonds )
2. Unsecured creditors (general creditors including debenture holders)
3. Subordinate debt holders
4. preferred stockholders
5. common stockholders
What is Liquidity Risk?
AKA Marketability Risk
The ease of converting an investment to cash without causing price disruption
When you’re ready to sell it, will someone buy it?
What is Currency/Exchange Risk?
Risk that arises from the fact that a currency’s value fluctuates against value of US dollar
What are the 8 main types of diversifiable (unsystematic) risk?
- Business Risk
- Financial Risk
- Credit Risk
- Regulatory Risk
5.Legislative Risk - Political Risk
- Sovereign Risk
- Country Risk
What is business risk?
Risk that can come from poor management (high for investors whose portfolios contain stock in only one issuer or in lower rated bonds)
What is financial risk?
Risk that debt leveraging could lead to bankruptcy
