Chapter 13- (1Q) Types of Investment Risk Flashcards
Systematic Risk
Risk associated with macroeconomic factors
Generally caused by factors that will effect all businesses such as war
Includes market risk, interest rate risk, and purchasing power risk
non-diversifiable risk
Market Risk
One way to protect against is to have negatively correlated assets in a portfolio
Measured by a securities beta
Longer your time horizon, less risk
Can also reduce by buying puts on a broad index
Interest Rate Risk
Interest rate movements will effect fixed income side of portfolio
Higher interest rates, lower prices go on existing bonds
Longer duration, the more risk subject to
Reinvestment Risk
Variation of interest rate risk
May not be able to find same return after a bond matures or pays out part of principal
Inflation Risk
Risk of inflation reducing the purchasing power of the dollar
TIPS are a good way to protect against
Equity securities are least susceptible
Unsystematic Risk
Reduced through diversification
Business, Financial, Liquidity, Political, Regulatory
Business Risk
Attributed to management of a company
Could either cause earnings estimates to come back lower or the company to go out of business
Buying an ETF greatly reduces risk
Financial Risk
Related to debt financing
Sometimes called credit or default risk
Buying a diversified portfolio of bonds lowers risk
Highest for those with stock in one issuer or in lowly rated bonds
Regulatory Risk
Sudden changes in regulation within a specific sector or for a specific business
Example would be the EPA rulings
“green” industries and those that tend to pollute
Legislative Risk
Change in law
Can be called political risk but most consider that to be separate thing
Tax code changes is most common
Political Risk
The risk of a political insurrection or coup
Split into two different types of risk:
Sovereign Risk- Risk of country defaulting on debt obligations
Country Risk- Evaluates total investment risk of a country
Includes qualitative and quantitative factors
Qualitative: Political risk, Economic perform, structural
Quant: Debt indicators, credit ratings, financing
Liquidity Risk
Risk that when an investor is wishing to withdraw funds, no one will be willing to buy it
Opportunity Cost
Return given up on an alternative investment
Currency or Exchange Rate Risk
Risk of foreign or the domestic currency following in value
May be asked about 2 different meals on different nights being the same cost in one currency and different in another
Capital Structure / Liquidation Priority
Important to understand the investors position in case of liquidation
Liquidation Order: Wages Taxes Secured Unsecured Subordinated Preferred Common
