Suitability And Prohibited Activities Flashcards
Market risk / systematic risk
Possibility that the value of an investment will fall due to a decline in the market as a whole.
Essential to investing in the market
Diversification will not protect from this type of risk
Interest rate risk
Risk that an investments value will change according the economy’s interest rates
Affects bonds more directly than stocks
Major risk to all bond holders
Duration
Tool used to determine the price sensitivity of a bond based on small rate change.
Higher is duration number will carry a higher interest rate risk
Bonds with a longer maturity or Lower coupon rate carry higher interest rate and will have a higher duration number
Reinvestment risk
Risk that future proceeds will have to be reinvested at a lower potential interest rate
Usually for bonds and preferred stocks
During falling interest rates
Prepayment risk
Common to mortgage or loan-backed securities
Existing loans to be paid off earlier than anticipated
Inflation / purchasing power risk
Most vulnerable to purchasing power risk
Rising prices mean money will buy less in the future than it does now
Currency /exchange risk
Occurs as the value of foreign currencies fluctuate against the US dollars
Non-systematic risk
The risk associated with a specific security, company, or industry, instead of overall market.
Can be lessened or eliminated thru diversification
Capital risk
Risk of losing some or all capital used to purchase an investment
Every investment is subject to this
Business / selection risk
The risk that a company will not have adequate cash flow to meet its operating expenses.
Considered a non systematic risk
Diversification reduces this risk
Liquidity / marketability risk
Risk resulting from the lack of marketability of an investment that cannot be sold quickly enough to prevent or minimize a loss or benefit from a potential gain
No ready buyers in the market
Credit / default risk
The possibility that an issuer will be unable to pay back the interest rate and or principal due to creditors
Fixed income securities like us treasury have no risk of default
Legislative risk
Change in the law can have major impact on company’s business
Social / political risk
Risk that an investments returns could suffer as a result of political changes, social events or instability in a country.
— govt legislative bodies, foreign policy markets, military control, excessive debt
Hedging
Reduce systematic risk like insurance
Long stock long put
Short stock long call
