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Flashcards in Risk Management Deck (17)
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1
Q
Define Market Risk
A
The risk that a sluggish economy will affect the value of a debt instrument
2
Q
Define Sector Risk
A
The risk that an event in the investment's business sector will harm the investment

For example- the banking sector is sluggish- so even stocks of healthy banks suffer
3
Q
Define Credit/Default Risk
A
The risk that a debtor will be unable to make loan payments or pay back the principal
4
Q
Define Interest Rate Risk
A
The risk that a change in interest rates will adversely affect the value of the note

Example: Bond is for 10% but prevailing market rate is now 12%. If bondholder wants to sell it- they will have to sell it at a discount.
5
Q
What does Standard Deviation measure?
A
It measures the volatility of an investment.
6
Q
What is Systematic Risk?
A
Risk that impacts the entire market and can't be avoided or reduced through diversification

Example: Wars
7
Q
What is Unsystematic Risk?
A
Relates to a particular industry or company

Example: You own stocks in ethanol plants and an untimely freeze kills all of the corn in the Midwest
8
Q
What does Beta measure?
A
Beta measures how volatile the investment is relative to the rest of the market.

In other words- how quickly (and in what amount) does the value of the stock change when the market sways?
9
Q
What is Variance?
A
It compares volatility of an investment to the market average.

Factors include both Systematic and Unsystematic Risk.
10
Q
What is a Derivative?
A
An asset whose value is DERIVED from the value of another asset.

Derivatives are measured at Fair Value.
11
Q
How is an Option used?
A
Gives the buyer the option to buy or sell a financial derivative at a certain price

Traders use them to speculate where they think the price will be at a certain point and make a profit

Hedgers use them to offset risk
12
Q
What is a Future?
A
A Forward Contract with a future value.

They are sold and traded on the futures market.
13
Q
What is an Interest Rate Swap?
A
Forward Contract to swap payment agreements

They are highly liquid and often valued using the Zero-Coupon method.

Example: Steve pays Sally a fixed payment with a fixed interest rate. Sally pays Steve a variable payment tied to a benchmark such as LIBOR
14
Q
What is Legal Risk?
A
Risk that a law or regulation will void the derivative
15
Q
What is a Fair Value Hedge?
A
Hedge that protects against the value of an asset or liability changing.

Changes in value are reported in earnings.
16
Q
What is a Cash Flow Hedge?
A
A hedge that protects against a set of future cash flows changing.

Changes in value are reported in OCI.
17
Q
What is a Foreign Currency Hedge?
A
A hedge that protects against the value of a foreign currency changing.

For example- a foreign currency hedge might be used to protect against the following: If you have receivables denominated in a foreign currency and that currency dips in value - your receivables are worth less than before.