A financial advisor is analyzing the risk profile of an investor's fixed-income portfolio, which is heavily concentrated in corporate bonds issued by a single pharmaceutical corporation. Which of the following statements correctly identify non-systematic or credit risks inherent to this corporate bond holding? (Select TWO)
- The risk that the issuing corporation experiences product failure, leading to financial distress and default on interest paymentsAnswer
- The risk that a major credit rating agency downgrades the issuer's credit rating due to deteriorating corporate earningsAnswer
- CThe risk that rising benchmark interest rates across the economy will depress the market value of all fixed-income securities
- DThe risk that unexpected economy-wide inflation erodes the purchasing power of fixed coupon payments over time
Answer
The risks that correctly represent non-systematic or credit risks are issuer default caused by corporate financial distress and a credit rating downgrade resulting from deteriorating corporate earnings.
Non-systematic risks are specific to a single business, industry, or debt issuer. Issuer default caused by corporate operational distress (such as product failure) and credit rating downgrades due to weak earnings are both specific to the single pharmaceutical entity. These risks can be effectively reduced or eliminated through portfolio diversification.
Step-by-Step Solution
Key Concept
Non-systematic risk refers to issuer-specific risks (such as credit risk, business risk, and default risk) that can be mitigated through portfolio diversification, unlike systematic market risks.