Chapter 20: Investment Risks

Are short term bonds or long term bonds more vulnerable to interest rate risk?

long term bonds are

Active Strategies

-market timing strategy -investors believe markets are not perfectly efficient -used to take advantage of anticipated economic events

Different types of systematic risk

-market risk (market fluctuations) -interest rate risk (bondholders suffer) -inflation (purchasing power) risk (decreases value of dollar) -event risk (catastrophic event such as 9/11)

tactical asset allocation

-market timing approach to investing

Beta above (below) 1.0

-above: greater volatility than the market -below: lower volatility than the market

strategic asset allocation

-allocating assets into an optimal portfolio based on a client's risk tolerance and investment objectives

Unsystematic risk

-based on circumstances that are unique to a specific security and may be managed by diversifying the assets in a portfolio (by selecting stocks with different risk return characteristics) ex: business, regulatory, legislative, political, liquidity, opportunity cost, etc.

Systematic (non-difersifiable) risks

-caused by factors that affect the prices of virtually all securities that cannot be avoidable through diversification

Indexing

-either maintaining investments in companies that are part of major stock (or bond) indexes or investing in index funds directly - passive approach

Hedging Option Types (3)

-equity -index -currency

sector rotation

-investment strategy that involves moving money from one industry or sector to another in an attempt to beat the market - active approach

Buy and Hold

-investor does not change her asset allocation -transaction costs and taxes are minimized bc less trades occurring -assets steadily appreciating -believe market is efficient - passive approach -however: risk reward characteristics are altered

Portfolio Rebalancing

-process of buying and selling assets on a periodic basis -the original strategic asset allocation and its risk reward characteristics can be restored -believe market is efficient - passive approach -however: more transaction costs

alpha

-risk specific to a company actual return - expected return

duration

-sensitivity of a bond or portfolio of bonds to a given change in interest rates -duration is measured in years

Beta

-volatility of equity securities

2 types of investment risks

systematic (non-diversifiable) and non-systematic (diversifiable)

Are bonds with lower coupon rates more sensitive to interest rate risk than bonds with higher ones?

yes