Unit 6 - Type of Risk Flashcards
The great the risk, the great the
Reward
What are the two categories within risk?
Systematic and nonsystematic risk
This is the risk that changes in the overall economy will have an adverse effect on individual securities, regardless of the company’s circumstances
Systematic risk
This type of risk can be affected by war, global security threats or inflation.
Systematic risk
One cannot diversify away _____ _____.
Systematic risk
This is the risk that when the overall market declines, so too will any portfolio made of securities the market comprises.
Market risk
This is the risk that is defined as a potential change in bond prices caused by a change in market interest rates after an issuer offers its bonds.
Interest rate risk
If interest rates rise ___ ____, existing bonds (with lower coupon) will be views as ___ ___ and will be priced in the market at a ___.
- Post-issuance
- Less attractive
- Discount
If rates ___, the existing bonds (with their higher coupons) will be viewed as ____ and will trade in the market at a ____.
- Fall
- Desirable
- Premium
If rates move up or down, the prices of bonds with ___ ___ will fluctuate more than bonds with ___ ___.
- Longer maturities
2. Shorter maturities
This is a word often used to express a bonds price sensitivity to interest rate swings.
Duration
When ___ ___ rise, the market price of bonds ___, and that is why this is a systematic risk for fixed-income securities.
- Interest rates
2. Falls
When interest rates rise, the market price of bonds falls, and that is why this is a systematic risk for fixed -income securities. This is also called?
Market risk for bonds
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
Reinvestment risk
This type of risk is also called purchasing power risk. It is the effect of continually rising prices on investment returns. If an investment yield is lower than the inflation rate, the purchasing power of the client’s money diminishes over time.
Inflation risk
This is a prolonged period of falling prices
Deflation
Falling prices would make fixed-income payments more ____ because bond investors could buy more good and services with their coupon payments.
Desirable
Systematic risk is
Nondiversifiable
This type of risk can be reduced through diversification. They are unique to a specific industry, business enterprise or investment type.
Nonsystematic risk
This measures the volatility of an asset.
Beta
The market has a beta of
1.00
If a security has a beta that is greater than 1.00, it is more
Volatile than the market
If a security has a beta of less than 1.00, it is
More stable than the market as a whole
Higher beta securities are considered
Riskier
This risk 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. This includes when a debt security fails to make interest payments.
Default risk
This is the risk that an investor will be unable to get all the investment back. It is minimal to none when investing in securities backed by the federal government, such as T-Bills, but could be far greater when investing in derivative products such as options and DPPs.
Capital Risk
This is an operating risk, generally cause by poor management decisions. Earnings are lower at best, and the company goes out of business at worst.
Business risk
This 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 total loss for the stockholders
Financial risk
This 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. It can lead to reinvestment risk.
Call risk
When interest rates are ____, bonds with higher coupon rates are most likely to be ___.
- Falling
2. Called
This is a period during which a bond cannot be called
Call protection
This is the risk that a borrower will repay the principal on a loan or debt instrument (bond) before its maturity and thus deprive the lend of future interest payments. It is often associated with call risk. GNMAs are subject to this risk because the underlying mortgages may be refinanced when interest rates fall.
Prepayment risk
This risk is the possibility that an investment denominated in one currency could decline if the value of that currency declined in its exchange rate with the US dollar.
Currency risk
____ is quoted at the spot rate, meaning a given currency’s current market value.
Currency
Currency is always quoted in relative terms between
Two currencies
This risk is when an investor might not be able to sell an investment quickly at a fair market price.
Liquidity risk or marketability risk
Most stocks and money markets are
Liquid
Real estate, fine art or collectibles are
Not generally liquid
This risk is a sudden change in the regulatory climate that can have a drastic effect on the performance of a business and entire business sectors. This includes changes in the rules that a business must comply with. Common examples are ruling made by the Environmental Protection Agency (EPA) or the Food and Drug Administration (FDA).
Regulatory risk
This risk results from a change in the law. It also includes changes to the tax code.
Legislative risk
This risk is the potential instability in the political underpinnings of the country.
Political risk
This is the risk that capture the risk of a country defaulting on its commercial debt obligations.
Sovereign risk
____ ____ is risk that s built into the system. The only way to mitigate or hedge this risk is to find an asset that will move in the opposite direction of the markets as a whole.
Systematic risk
Building a portfolio that consists of securities of several different issuers is called what?
Diversification
What are the risks that fall under systematic?
- Market risk
- Interest rate risk
- Reinvestment risk
- Inflation risk (purchasing power risk)
What are the risks that fall under nonsystematic?
- Default risk
- Business risk
- Financial risk
- Call risk
- Prepayment risk
- Currency risk
- Liquidity risk
- Regulatory risk
- Legislative risk
- Political risk
- Sovereign risk
