Unit 6 - Type of Risk

Question 1

The great the risk, the great the

Answer 1

Reward

Question 2

What are the two categories within risk?

Answer 2

Systematic and nonsystematic risk

Question 3

This is the risk that changes in the overall economy will have an adverse effect on individual securities, regardless of the company’s circumstances

Answer 3

Systematic risk

Question 4

This type of risk can be affected by war, global security threats or inflation.

Answer 4

Systematic risk

Question 5

One cannot diversify away _____ _____.

Answer 5

Systematic risk

Question 6

This is the risk that when the overall market declines, so too will any portfolio made of securities the market comprises.

Answer 6

Market risk

Question 7

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.

Answer 7

Interest rate risk

Question 8

If interest rates rise ___ ____, existing bonds (with lower coupon) will be views as ___ ___ and will be priced in the market at a ___.

Answer 8

1. Post-issuance
2. Less attractive
3. Discount

Question 9

If rates ___, the existing bonds (with their higher coupons) will be viewed as ____ and will trade in the market at a ____.

Answer 9

1. Fall
2. Desirable
3. Premium

Question 10

If rates move up or down, the prices of bonds with ___ ___ will fluctuate more than bonds with ___ ___.

Answer 10

1. Longer maturities

2. Shorter maturities

Question 11

This is a word often used to express a bonds price sensitivity to interest rate swings.

Answer 11

Duration

Question 12

When ___ ___ rise, the market price of bonds ___, and that is why this is a systematic risk for fixed-income securities.

Answer 12

1. Interest rates

2. Falls

Question 13

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?

Answer 13

Market risk for bonds

Question 14

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

Answer 14

Reinvestment risk

Question 15

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.

Answer 15

Inflation risk

Question 16

This is a prolonged period of falling prices

Answer 16

Deflation

Question 17

Falling prices would make fixed-income payments more ____ because bond investors could buy more good and services with their coupon payments.

Answer 17

Desirable

Question 18

Systematic risk is

Answer 18

Nondiversifiable

Question 19

This type of risk can be reduced through diversification. They are unique to a specific industry, business enterprise or investment type.

Answer 19

Nonsystematic risk

Question 20

This measures the volatility of an asset.

Answer 20

Beta

Question 21

The market has a beta of

Answer 21

1.00

Question 22

If a security has a beta that is greater than 1.00, it is more

Answer 22

Volatile than the market

Question 23

If a security has a beta of less than 1.00, it is

Answer 23

More stable than the market as a whole

Question 24

Higher beta securities are considered

Answer 24

Riskier

Question 25

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.

Answer 25

Default risk

Question 26

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.

Answer 26

Capital Risk

Question 27

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.

Answer 27

Business risk

Question 28

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

Answer 28

Financial risk

Question 29

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.

Answer 29

Call risk

Question 30

When interest rates are ____, bonds with higher coupon rates are most likely to be ___.

Answer 30

1. Falling

2. Called

Question 31

This is a period during which a bond cannot be called

Answer 31

Call protection

Question 32

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.

Answer 32

Prepayment risk

Question 33

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.

Answer 33

Currency risk

Question 34

____ is quoted at the spot rate, meaning a given currency’s current market value.

Answer 34

Currency

Question 35

Currency is always quoted in relative terms between

Answer 35

Two currencies

Question 36

This risk is when an investor might not be able to sell an investment quickly at a fair market price.

Answer 36

Liquidity risk or marketability risk

Question 37

Most stocks and money markets are

Answer 37

Liquid

Question 38

Real estate, fine art or collectibles are

Answer 38

Not generally liquid

Question 39

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).

Answer 39

Regulatory risk

Question 40

This risk results from a change in the law. It also includes changes to the tax code.

Answer 40

Legislative risk

Question 41

This risk is the potential instability in the political underpinnings of the country.

Answer 41

Political risk

Question 42

This is the risk that capture the risk of a country defaulting on its commercial debt obligations.

Answer 42

Sovereign risk

Question 43

____ ____ 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.

Answer 43

Systematic risk

Question 44

Building a portfolio that consists of securities of several different issuers is called what?

Answer 44

Diversification

Question 45

What are the risks that fall under systematic?

Answer 45

1. Market risk
2. Interest rate risk
3. Reinvestment risk
4. Inflation risk (purchasing power risk)

Question 46

What are the risks that fall under nonsystematic?

Answer 46

1. Default risk
2. Business risk
3. Financial risk
4. Call risk
5. Prepayment risk
6. Currency risk
7. Liquidity risk
8. Regulatory risk
9. Legislative risk
10. Political risk
11. Sovereign risk