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Investments (securities) > Unit 6 > Flashcards

Unit 6 Flashcards

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SIE Exam flashcards
1
Q

What are the TWO TYPES OF RISK?

A

systematic and nonsystematic

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2
Q

What is a SYSTEMATIC RISK?

A

is the risk that changes in the OVERALL ECONOMY will have an ADVERSE EFFECT on INDIVIDUAL SECURITIES, regardless of the COMPANY’S CIRCUMSTANCES.

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3
Q

What causes SYSTEMATIC RISK?

A

It is generally caused by FACTORS THAT AFFECT ALL BUSINESSES:

such as war, global security threats, or inflation.

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4
Q

What is INTEREST RATE RISK?

A

is defined as a POTENTIAL CHANGE IN BOND PRICES caused by a CHANGE IN MARKET INTEREST RATES after AN ISSUER OFFERS ITS BONDS.

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5
Q

The relationship between the direction of rates and bond price is said to be

A

Inverse

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6
Q

The RISK that when the OVERALL MARKET DECLINES, so too will ANY PORTFOLIO made of securities the market comprises.

A

MARKET RISK

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7
Q

If INTEREST RATES rise POST-ISSUANCE, existing bonds (with a lower coupon) will be viewed as

A

LESS ATTRACTIVE and will be priced in the market at a DISCOUNT.

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8
Q

When INTEREST RATES RISE, the MARKET PRICE OF BONDS

A

falls, and that is why this is a SYSTEMATIC RISK for FIXED-INCOME SECURITIES. This risk is sometimes called the MARKET RISK FOR BONDS.

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9
Q

Regarding DURATION, if rates move UP OR DOWN, the PRICES OF BONDS WITH LONGER MATURITIES will fluctuate ______ than BONDS WITH SHORTER MATURITIES, because this INTEREST RATE DIFFERENTIAL is potentially _______ lived.

A

More

Longer

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10
Q 
When the INTEREST RATE paid on a DEBT SECURITY is LESS THAN THE CURRENT INFLATION RATE, the INVESTOR SUFFERS from which of the following RISKS? 
A. Liquidity risk 
B. Call risk 
C. Purchasing power risk 
D. Currency risk
A

C. Purchasing power risk

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11
Q

Your customer has carefully researched the purchase of stock in Green Shoe Company.

After the purchase, the equity markets dropped 20%, and Green Shoe stocked dropped along with it.

Green Shoe gave up 15% during the drop. This is an example of

A. business risk.
B. interest rate risk.
C. market risk.
D. nonsystematic risk.

A

C. market risk.

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12
Q

What is REINVESTMENT RISK?

A

This is a VARIATION of INTEREST RATE RISK.

When interest rates decline, it is difficult to reinvest proceeds from redemptions, securities that have been called (call risk), or investment distributions and maintain the same level of income without increasing credit or market risks.

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13
Q

What is an ALTERNATE NAME for INFLATION RISK?

A

purchasing power risk

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14
Q

What is deflation and how does it affect fixed-income payments?

A

deflation is a prolonged period of falling prices. Falling prices would make fixed-income payments MORE VALUABLE because bond investors could buy more goods and services with their coupon payments.

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15
Q

Describe inflation risk

A

is the effect of continually rising prices on investment returns. If an investment’s yield is lower than the inflation rate, the purchasing power of the client’s money diminishes over time.

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16
Q

If a security has a beta that is greater than 1.00, it is _______1________ than the market. If an asset has a beta of less than 1.00, it is ____2____than the market as a whole. The bottom line is that a high beta security is considered __3__.

A
  1. more volatile
  2. more stable
  3. riskier
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17
Q

What is Default risk ?

A

is the potential for an investor to lose some or all of their money—their invested capital—under circumstances related to an issuer’s financial strength. Default risk includes the risk that a debt security fails to make interest payments.

18
Q

What is a business risk?

A

is an operating risk, generally caused by poor management decisions. At best, earnings are lowered; at worst, the company goes out of business and common stockholders could lose their entire investment.

19
Q

What is financial risk?

A

Often confused with business risk (it is similar), financial risk relates primarily to those companies that use debt financing (leverage). An inability to meet the interest and principal payments on those debt obligations could lead to bankruptcy and, once again, total loss for the stockholders. For that reason, this is sometimes called credit risk or default risk.

20
Q

What is nonsystematic risk?

A

these risks can be reduced through diversification. They are risks that are unique to a specific industry, business enterprise, or investment type.

21
Q

____measures the volatility of an asset

A

Beta

22
Q

What are some nonsystematic risks?

A 
Default risk 
Business risk
Capital risk
Financial risk
Call risk
Prepayment risk
Currency risk
Liquidity risk
23
Q

Describe capital risk

A

is simply the risk that an investor will be unable to get all the investment back. It varies depending on the type of security and the specific issuer.

24
Q

One of the advantages of a security being traded on a listed stock exchange is the ready availability of buyers and sellers. This has the tendency to reduce or even eliminate
A. inflation risk. B. liquidity risk. C. market risk. D. price risk.

A

B

25
Q

Before making an investment, it is wise to evaluate the potential risk involved. It is safe to assume that
I. the greater the risk, the greater the potential reward. II. the greater the risk, the lower the potential reward. III. the lower the risk, the greater the potential loss.
IV. the lower the risk, the lower the potential reward.
A. I and III B. I and IV C. II and III D. II and IV

A

B

26
Q

What is diversification in terms of hedge risk?

A

The most common way to hedge risks that a specific security may carry is to build a portfolio that consists of securities of several different issuers

27
Q

What is a call risk?

A

is the risk that a bond might be called before maturity and an investor will be unable to reinvest the principal at a comparable rate of return.

28
Q

the occurrence of call risk can lead to _________risk

A

reinvestment

29
Q

What is call protection?

A

a period during which a bond cannot be called. Most corporate and municipal issuers generally provide some years of call protection.

30
Q

What is Currency risk

A

is the possibility that an investment denominated in one currency could decline if the value of that currency declines in its exchange rate with the U.S. dollar.

31
Q

Describe prepayment risk

A

is the risk that a borrower will repay the principal on a loan or debt instrument (bond) before its maturity and thus deprive the lender of future interest payments. This risk is often associated with call risk

32
Q

What is Liquidity risk?

A

risk that an investor might not be able to sell an investment quickly at a fair market price is known as liquidity risk or marketability risk.

33
Q

When _______ are falling,_____ with _________coupon ___ are most likely to be called

A

interest rates are falling, bonds with higher coupon rates

34
Q

What is mean’t by spot rate?

A

Currency is quoted at the spot rate, meaning a given currency’s current market value. Currency is always quoted in relative terms between two currencies.

35
Q

Describe political risk

A

can be interrelated with legislative risk, most attribute this risk specifically to the potential instability in the political underpinnings of the country.

36
Q

What is Sovereign risk?

A

Sovereign risk ratings capture the risk of a country defaulting on its commercial debt obligations. When a country is at risk of defaulting on its debt, the impact is felt on financial markets worldwide.

37
Q

How can one mitigate systematic risk?

A

The only way to mitigate or hedge systematic risk is to find an asset that will move in the opposite direction of the markets as a whole. Portfolio managers will use derivative securities to hedge the portfolio risk.

38
Q

Describe legislative risk

A

It is common to lump together regulatory and legislative risk, but there is a difference. Whereas regulatory risk comes from a change to regulations, legislative risk results from a change in the law. A government agency, state or federal, may pass certain regulations, but only a legislature can pass a law.

39
Q

Explain regulatory risk

A

A sudden change in the regulatory climate can have a dramatic effect on the performance of a business and entire business sectors. Changes in the rules that a business must comply with can devastate individual companies and industries almost overnight.

40
Q

Give an example of regulatory risk?

A

Common examples of this risk are rulings made by the Environmental Protection Agency (EPA) or the Food and Drug Administration (FDA).

41
Q

What is a common legislative risk?

A

Changes to the tax code are the most obvious legislative risks.

Investments (securities) (15 decks)

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