Portfolio Analysis & Risk Management Flashcards

What is a 'bond ladder' strategy and what risk does it address?

Answer: Purchasing bonds with staggered maturities so proceeds are regularly reinvested; manages interest rate and reinvestment risk

A bond ladder involves buying bonds with different maturity dates so that bonds mature regularly, providing liquidity and the opportunity to reinvest at prevailing rates, managing both interest rate risk and reinvestment risk.

What is 'correlation' in portfolio construction and why does low correlation between assets matter?

Answer: A statistical measure of how two investments move in relation to each other; low/negative correlation means assets move independently, reducing portfolio volatility

Correlation measures how two assets move together; combining low or negatively correlated assets means when one falls, the other may not or may rise, reducing overall portfolio volatility without necessarily reducing expected return.

What is 'Value at Risk' (VaR) as a risk management tool?

Answer: A statistical estimate of the maximum potential loss over a specified time period at a given confidence level

VaR estimates the maximum loss a portfolio could experience over a specific period (e.g., one day) at a given confidence level (e.g., 95%), meaning there is only a 5% probability of losing more than the VaR amount.

What is a 'target-date fund' and for whom is it most suitable?

Answer: A fund that automatically shifts to a more conservative allocation as the target retirement date approaches; suitable for retirement savers who want a hands-off approach

Target-date funds automatically adjust their asset allocation from aggressive (more stocks) to conservative (more bonds) as the target retirement year approaches, making them ideal for retirement savers who prefer a set-it-and-forget-it approach.

What is 'credit risk' and how is it assessed for bonds?

Answer: The risk that a bond issuer will fail to make promised payments; assessed by credit rating agencies like Moody's, S&P, and Fitch

Credit risk is the risk that a bond issuer will default on principal or interest payments; investors rely on credit rating agencies (Moody's, S&P, Fitch) to assess this risk, with investment-grade ratings (BBB-/Baa3 or higher) indicating lower risk.

What is 'liquidity risk' in the context of securities investing?

Answer: The risk that an investor cannot sell a security quickly at a fair price without significantly impacting its price

Liquidity risk is the risk that an investor cannot exit a position quickly at or near its fair market value because there are insufficient buyers or sellers, often resulting in having to accept a lower price.