A fixed-income portfolio manager constructs an investment portfolio composed strictly of investment-grade corporate bonds across twenty distinct industrial sectors to eliminate issuer-specific credit default risk. Following an unexpected series of interest rate increases by the Federal Reserve to combat inflation, market prices across all held bonds decline sharply simultaneously. Which of the following statements best explains why the manager's diversification strategy failed to protect the portfolio from this market downturn?
- Diversification across sectors eliminates unsystematic credit risk, but interest rate risk is a systematic risk that impacts the entire fixed-income market regardless of issuer diversification.Cevap
- BSpreading capital across multiple corporate sectors increases the portfolio's exposure to interest rate fluctuations because interest rate risk is an unsystematic risk factor unique to multi-sector funds.
- CThe simultaneous decline occurred because rising interest rates drive prevailing bond yields downward, which reduces secondary market market valuations for fixed-income instruments.
- DThe price drop was driven by widespread credit risk contagion across corporate issuers, which is the primary systematic risk factor measured during monetary policy shifts.
Cevap
Diversification across sectors eliminates unsystematic credit risk, but interest rate risk is a systematic risk that impacts the entire fixed-income market regardless of issuer diversification.
Interest rate risk is a form of systematic (market-wide) risk. While diversification across issuers and industrial sectors can substantially reduce or eliminate unsystematic risks like corporate credit default risk, it cannot shield fixed-income securities from broad macroeconomic factors like central bank interest rate adjustments, which drive down existing bond valuations across the board.
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Systematic Risk and the Limits of Diversification