Chapter 19 (6 Questions)

Question 1

Systematic risk

Answer 1

risk in the return of an investment that is associated with the macroeconomic factors that affect all risky assets. — Risk of the OVERALL ECONOMY

Question 2

Market Risk

Answer 3

nondiversifiable - When the market tanks, virtually all securities lose value– Having negatively correlated assets may help protect against market risk

Question 4

Interest Rate Risk

Answer 4

When interest rates rise, the market price of bonds falls; that is why this is a systematic risk

Question 5

Reinvestment Risk

Answer 5

A variation of interest rate risk is reinvestment risk. There is reinvestment risk as to interest and reinvestment risk as to principal.

Question 6

Inflation Risk (Purchasing Power Risk)

Answer 6

systematic risk. Inflation reduces the buying power of a dollar (or whatever currency is used where you live)

Question 7

Exchange Rate or Currency Risk

Answer 7

the uncertainty that the value of either the foreign currency or the domestic currency will fluctuate.

Question 8

unsystematic risks

Answer 8

can be reduced through diversification.

Question 9

Business Risk

Answer 9

operating risk, generally caused by poor management decisions

Question 10

Financial Risk

Answer 10

financial risk relates primarily to those companies that use debt financing (leverage) DIVERSIFIABLE, nonsystemic

Question 11

Regulatory Risk

Answer 11

a change in regulations-can have a dramatic effect on the performance or risk of a business and entire business sectors

Question 12

Political Risk

Answer 12

most attribute this to potential instability in the political underpinnings of the country (think of a coup)– Think emerging economies

Question 13

Sovereign Risk

Answer 13

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

Question 14

Country Risk

Answer 14

monitors the political and economic stability of countries. Country risk is the total risk of investing in the obligations of that country and includes political, financial, and sovereign risk.

Question 15

Liquidity Risk

Answer 15

How fast a security can turn to cash

Question 16

Opportunity cost

Answer 16

is the foregone return, or the return given up, on an alternative investment.

Question 18

Liquidation Priority

Answer 18

1-Secured creditors (e.g., mortgage bonds,equipment trust certificates, collateral trust bonds). These may be called senior debt or even senior notes on the exam.
2-Unsecured creditors (e.g., general creditors including debenture holders)
3-Subordinated debt holders
2-Preferred stockholders
1-Common stockholders