Examkin

Question

Difficulty: Very hardNon-Systematic and Credit Risks

An investor holds a fixed-income portfolio containing U.S. Treasury notes, municipal general obligation bonds, and senior unsecured debt issued by a global logistics corporation. Following a catastrophic cyberattack that permanently disables the logistics corporation's primary routing infrastructure, major credit rating agencies downgrade the corporation's debt from BBBBBB to CCCCCC. The market value of the corporate bonds drops significantly, while U.S. Treasury prices remain stable. Which of the following risks best identifies the specific hazard that caused the price decline in the logistics corporation's bonds?

  1. Credit risk, a non-systematic risk unique to the issuing entity's financial stability and operational performanceAnswer
  2. B
    Interest rate risk, a systematic risk driven by macroeconomic shifts in prevailing benchmark yields
  3. C
    Legislative risk, a systematic market risk resulting from changes in statutory regulations or federal laws
  4. D
    Purchasing power risk, a systematic risk caused by economy-wide inflationary erosion of fixed coupon income

Answer

Credit risk, a non-systematic risk unique to the issuing entity's financial stability and operational performance
The correct option correctly identifies credit risk as a non-systematic (unsystematic) risk. Credit risk refers to the danger that an issuer will fail to pay interest or principal in a timely manner, or suffer a downgrade in credit rating due to operational or financial difficulties. Because this cyberattack affected only the logistics corporation and left U.S. Treasuries unaffected, the loss is attributable to company-specific non-systematic risk.

Step-by-Step Solution

1
Analyze the source of the event described in the scenario
The event is a cyberattack causing operational disruption and a debt downgrade for a single corporate issuer.
Determining whether the event is company-specific or market-wide distinguishes non-systematic risk from systematic risk.
2
Evaluate the impact on the portfolio's securities
Only the corporate debt declined in price following the downgrade, while U.S. Treasuries remained stable.
Systematic risks affect the overall market broadly, whereas non-systematic risks can be isolated to a specific security or issuer.
3
Identify the risk category corresponding to issuer default or rating downgrade
The risk of financial loss due to an issuer's potential default or rating downgrade is credit (default) risk.
Credit risk is a classic form of non-systematic risk that can be mitigated through portfolio diversification.

Key Concept

Credit risk (financial or default risk) is a non-systematic risk specific to an individual issuer that can be reduced through diversification, unlike systematic market-wide risks such as interest rate or inflation risk.
Estimated Time:1m 30s
Rate this question

Topics

Non-Systematic and Credit Risks

More questions from this topic