An investor holds corporate bonds issued by a single technology hardware manufacturer. Following a series of Federal Reserve interest rate increases, market prices for all debt securities decline across the economy. Simultaneously, the hardware manufacturer experiences a critical supply chain failure, leading to reduced corporate earnings and a credit rating downgrade by a major rating agency. Which of the following best categorizes the specific risk associated with the manufacturer's supply chain failure and credit downgrade?
- Non-systematic risk, because it is unique to the specific issuer and can be mitigated through asset diversification.Answer
- BSystematic risk, because the price drop was triggered by changes in benchmark macroeconomic interest rates.
- CMarket risk, because credit rating downgrades inherently affect the broad market index.
- DPurchasing power risk, because credit downgrades reduce the inflation-adjusted value of fixed income payments.
Answer
Non-systematic risk, because it is unique to the specific issuer and can be mitigated through asset diversification.
The correct answer identifies the supply chain disruption and credit rating downgrade as non-systematic risk. Non-systematic (or unsystematic) risks are tied to specific issuers or business entities (such as credit risk, business risk, or financial risk). Because these factors are specific to the company, investors can effectively reduce or eliminate this risk by constructing a diversified portfolio.
Step-by-Step Solution
Key Concept
Non-Systematic Risk and Credit Risk