Risk Types and Portfolio Concepts
Flashcards covering systematic vs. unsystematic risks, key risk definitions, and diversification/correlation ideas for the SIE exam.
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Questions Covered in This Set
10 cards to master
What is systematic risk, and can diversification eliminate it?
Market-wide (non-diversifiable) risk that affects all securities at once — diversification cannot remove it. Measured by beta. Includes market, interest rate, inflation, and reinvestment risk.
What does beta measure? What do beta 1.5 and 0.6 mean?
Volatility relative to the overall market. Beta 1.0 = moves with the market; 1.5 = 50% more volatile; 0.6 = less volatile than the market.
Which bonds are hit hardest by interest rate risk?
Long-maturity, low-coupon bonds — a 30-year zero-coupon Treasury is the extreme case (no credit risk, huge interest rate risk).
What is inflation (purchasing power) risk, and what hedges it?
Risk that fixed dollars buy less later; worst for long bonds, fixed annuities, and CDs. Hedges: common stock, real estate, and TIPS.
What is reinvestment risk, and which bond has none?
Risk that falling rates force coupons/principal to be reinvested at lower yields. Zero-coupon bonds have NO reinvestment risk because there are no coupons.
Name the main unsystematic (diversifiable) risks.
Business, credit/default, liquidity, legislative/regulatory, political, currency, prepayment/extension, and call risk.
Where is the line between investment grade and junk bonds?
Investment grade is BBB/Baa and above; junk (high-yield) is BB/Ba and below — lower ratings demand higher yields.
Which products carry the most liquidity risk?
DPPs/limited partnerships, non-traded REITs, hedge funds with lockups, thinly traded munis, and restricted stock.
Explain prepayment vs. extension risk on mortgage-backed securities.
Rates fall → homeowners refinance and principal comes back early (prepayment). Rates rise → no refinancing and money stays invested longer (extension).
What correlation levels reduce portfolio volatility?
Low or negative correlation (toward −1.0). Correlation runs +1.0 to −1.0; 20 tech stocks (~+0.9) is not diversification. Diversification cuts unsystematic risk only — beta remains.
