In portfolio risk management, systematic risks affect the financial system as a whole and cannot be eliminated through asset diversification. Match each systematic risk subtype on the left with the market scenario on the right that best illustrates its impact.
- Interest Rate RiskA long-term fixed-income investor sees the secondary market prices of existing bonds drop following a series of Federal Reserve rate increases.
- Purchasing Power (Inflation) RiskA retiree receiving fixed monthly annuity payments notices a decline in real purchasing power during a sustained surge in the Consumer Price Index (CPI).
- Currency (Exchange Rate) RiskA U.S. investor holding foreign equity securities receives lower net U.S. dollar dividend payouts because the foreign currency weakened relative to the U.S. dollar.
- Reinvestment RiskAn investor holding a maturing high-coupon bond is forced to invest the returned principal into new securities offering lower prevailing yields.
Answer
Interest Rate Risk matches with existing bond price declines due to Fed rate hikes; Purchasing Power Risk matches with reduced real value of fixed annuity payouts during CPI surges; Currency Risk matches with reduced U.S. dollar dividend returns from foreign securities due to foreign currency depreciation; Reinvestment Risk matches with redeploying principal from maturing high-coupon bonds into lower-yielding securities.
Each systematic risk subtype is paired with its definitive economic scenario: Interest Rate Risk drives inverse bond price adjustments; Purchasing Power Risk erodes real purchasing power via CPI surges; Currency Risk reflects foreign exchange volatility impacting cross-border cash flows; and Reinvestment Risk arises when maturing funds must be redeployed at prevailing lower yields.
Step-by-Step Solution
Key Concept
Systematic risks are macro-level market risks, including interest rate, inflation, currency, and reinvestment risks, that affect broad market segments and cannot be diversified away.