4.d Flashcards
(14 cards)
What is the difference between systematic and nonsystematic risk?
Systematic Risk: A risk that affects the entire market or economy. It cannot be eliminated through diversification.
Nonsystematic Risk: A risk that affects a specific company or industry. It can be reduced through diversification.
What is business risk?
The risk that a specific company will fail due to poor management or other negative circumstances unique to that company or industry.
This risk can be reduced by diversifying.
What is credit risk? What type of security does it affect?
The danger of losing your principal because an issuer fails to make interest or principal payments. It is the risk of default.
This risk is associated with debt securities (bonds), not equity. Government bonds have low credit risk; lower-rated corporate bonds have high credit risk.
What is liquidity risk?
The risk that you might not be able to sell an investment quickly at its current market price.
Investments like real estate or thinly traded stocks have high liquidity risk.
What is legislative or political risk?
The risk that a change in laws (legislative) or political instability (political) could negatively impact an investment’s value.
Political risk is especially important to consider for international investments.
What is capital risk?
The risk that an investor could lose all of their invested capital (their principal).
What is timing risk?
The risk of buying or selling at the wrong time, resulting in losses or lower gains. This risk particularly affects short-term traders.
What is market risk?
The risk that an investment will decline in value because the entire market is declining.
You cannot diversify away market risk.
What is interest rate risk?
The risk that an investment’s value will change due to a change in interest rates.
When interest rates rise, the prices of existing bonds fall. Long-term bonds have more interest rate risk (are more price volatile) than short-term bonds.
What is inflation risk?
The risk that the return from an investment will not keep pace with rising prices (inflation), resulting in a loss of purchasing power.
This risk is particularly significant for fixed-income investments like bonds and fixed annuities.
What is reinvestment risk?
The risk that when a bond matures or is called, an investor will not be able to reinvest the principal at a comparable interest rate.
This risk is highest when interest rates are falling.
What is call risk? What kind of bonds are most likely to be called?
The risk that the issuer will ‘call’ (redeem) a bond before its maturity date. This typically happens when interest rates are falling.
Bonds with high coupon rates are most likely to be called. Investors concerned about this should look for bonds with call protection.
What is currency risk?
The risk that a change in the exchange rate between currencies will negatively impact an investment.
If you own a foreign investment and the U.S. dollar strengthens (appreciates), the value of your investment will decrease.
What is bond duration, and what does it measure?
Duration is a measure of a bond’s sensitivity to changes in interest rates.
The longer a bond’s duration, the more volatile its price will be when interest rates change (meaning it has higher interest rate risk). A zero-coupon bond’s duration is always equal to its time to maturity.
