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Difficulty: Very hardNon-Systematic and Credit Risks

Match each investor scenario involving non-systematic or credit risk to the specific category of risk it primarily illustrates.

  • A municipal revenue bond issuer experiences severe revenue shortfalls from toll facilities and defaults on its scheduled principal payment to debt holders.Credit Risk
  • An equity investor holding a concentrated position in a single manufacturing firm suffers losses due to product recalls and executive mismanagement during a broad bull market.Business Risk
  • An institutional investor holding unrated private debt securities needs immediate cash but must accept a substantial discount to complete a transaction due to a lack of active market participants.Liquidity Risk
  • A specialized utility fund experiences a sharp decline in asset value immediately following the passage of new federal emissions control statutes that increase compliance costs for target firms.Legislative Risk

Answer

The municipal bond default corresponds to Credit Risk; the manufacturing stock loss caused by management failures corresponds to Business Risk; the discount required to sell unrated debt quickly corresponds to Liquidity Risk; and the fund decline caused by new federal laws corresponds to Legislative Risk.
Each scenario accurately illustrates a key form of non-systematic or credit risk: failing to honor debt payments illustrates Credit Risk; internal operational defects and executive missteps illustrate Business Risk; secondary market illiquidity forcing price concessions illustrates Liquidity Risk; and adverse statutory law changes illustrate Legislative Risk.

Step-by-Step Solution

1
Analyze the municipal bond scenario where an issuer fails to make scheduled principal debt payments.
The failure to fulfill debt obligations represents issuer default.
Default on interest or principal obligations directly defines credit risk.
2
Evaluate the equity loss stemming from executive errors and product recalls during an economic expansion.
The issue is unique to the operational management of the firm rather than systemic market movements.
Company-specific operational and managerial failures exemplify business risk.
3
Examine the unrated private debt holding requiring a price concession for fast conversion to cash.
The difficulty arises from trading friction and lack of secondary market depth.
The inability to sell an asset quickly without sacrificing value is the definition of liquidity risk.
4
Assess the utility fund decline resulting from newly enacted federal statutory mandates.
The risk materialized directly from government lawmaking.
Losses resulting from new congressional statutes or legislative changes constitute legislative risk.

Key Concept

Specific Categories of Non-Systematic and Credit Risk
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Topics

Non-Systematic and Credit Risks

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