Unit 6 Flashcards
(41 cards)
What are the TWO TYPES OF RISK?
systematic and nonsystematic
What is a SYSTEMATIC RISK?
is the risk that changes in the OVERALL ECONOMY will have an ADVERSE EFFECT on INDIVIDUAL SECURITIES, regardless of the COMPANY’S CIRCUMSTANCES.
What causes SYSTEMATIC RISK?
It is generally caused by FACTORS THAT AFFECT ALL BUSINESSES:
such as war, global security threats, or inflation.
What is INTEREST RATE RISK?
is defined as a POTENTIAL CHANGE IN BOND PRICES caused by a CHANGE IN MARKET INTEREST RATES after AN ISSUER OFFERS ITS BONDS.
The relationship between the direction of rates and bond price is said to be
Inverse
The RISK that when the OVERALL MARKET DECLINES, so too will ANY PORTFOLIO made of securities the market comprises.
MARKET RISK
If INTEREST RATES rise POST-ISSUANCE, existing bonds (with a lower coupon) will be viewed as
LESS ATTRACTIVE and will be priced in the market at a DISCOUNT.
When INTEREST RATES RISE, the MARKET PRICE OF BONDS
falls, and that is why this is a SYSTEMATIC RISK for FIXED-INCOME SECURITIES. This risk is sometimes called the MARKET RISK FOR BONDS.
Regarding DURATION, if rates move UP OR DOWN, the PRICES OF BONDS WITH LONGER MATURITIES will fluctuate ______ than BONDS WITH SHORTER MATURITIES, because this INTEREST RATE DIFFERENTIAL is potentially _______ lived.
More
Longer
When the INTEREST RATE paid on a DEBT SECURITY is LESS THAN THE CURRENT INFLATION RATE, the INVESTOR SUFFERS from which of the following RISKS? A. Liquidity risk B. Call risk C. Purchasing power risk D. Currency risk
C. Purchasing power risk
Your customer has carefully researched the purchase of stock in Green Shoe Company.
After the purchase, the equity markets dropped 20%, and Green Shoe stocked dropped along with it.
Green Shoe gave up 15% during the drop. This is an example of
A. business risk.
B. interest rate risk.
C. market risk.
D. nonsystematic risk.
C. market risk.
What is REINVESTMENT RISK?
This is a VARIATION of INTEREST RATE RISK.
When interest rates decline, it is difficult to reinvest proceeds from redemptions, securities that have been called (call risk), or investment distributions and maintain the same level of income without increasing credit or market risks.
What is an ALTERNATE NAME for INFLATION RISK?
purchasing power risk
What is deflation and how does it affect fixed-income payments?
deflation is a prolonged period of falling prices. Falling prices would make fixed-income payments MORE VALUABLE because bond investors could buy more goods and services with their coupon payments.
Describe inflation risk
is the effect of continually rising prices on investment returns. If an investment’s yield is lower than the inflation rate, the purchasing power of the client’s money diminishes over time.
If a security has a beta that is greater than 1.00, it is _______1________ than the market. If an asset has a beta of less than 1.00, it is ____2____than the market as a whole. The bottom line is that a high beta security is considered __3__.
- more volatile
- more stable
- riskier
What is Default risk ?
is the potential for an investor to lose some or all of their money—their invested capital—under circumstances related to an issuer’s financial strength. Default risk includes the risk that a debt security fails to make interest payments.
What is a business risk?
is an operating risk, generally caused by poor management decisions. At best, earnings are lowered; at worst, the company goes out of business and common stockholders could lose their entire investment.
What is financial risk?
Often confused with business risk (it is similar), financial risk relates primarily to those companies that use debt financing (leverage). An inability to meet the interest and principal payments on those debt obligations could lead to bankruptcy and, once again, total loss for the stockholders. For that reason, this is sometimes called credit risk or default risk.
What is nonsystematic risk?
these risks can be reduced through diversification. They are risks that are unique to a specific industry, business enterprise, or investment type.
____measures the volatility of an asset
Beta
What are some nonsystematic risks?
Default risk Business risk Capital risk Financial risk Call risk Prepayment risk Currency risk Liquidity risk
Describe capital risk
is simply the risk that an investor will be unable to get all the investment back. It varies depending on the type of security and the specific issuer.
One of the advantages of a security being traded on a listed stock exchange is the ready availability of buyers and sellers. This has the tendency to reduce or even eliminate
A. inflation risk. B. liquidity risk. C. market risk. D. price risk.
B
