DOCSLIB.ORG

Assessing Securities Lending Risk-Return Performance in a Portfolio Context

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
Assessing Securities Lending Risk-Return Performance in a Portfolio Context Asset-Based Lending Assessing Securities Lending Risk-Return Performance in a Portfolio Context by Ben Atkins and Glenn Horner hile many institutional investors embrace paying a rebate rate on this cash collateral.1 Demand securities lending as an attractive tool to to borrow securities usually causes the rebate rate to enhance portfolio returns, others remain wary. fall below the risk-free rate (the line). For some secu- WMany perceive securities lending to be an eso- rities, this spread is quite substantial; the demand teric distraction—a tool limited by risky, immaterial spread represents the “specialness” of a security to returns. State Street addresses the latter view by borrowers. Some lenders are content with the grounding investors’ performance analysis on risk- demand spread; they simply invest the cash collateral adjusted returns. The data lead to two key conclu- in Treasury repo. Most lenders, however, seek addi- sions for investment managers and plan sponsors: tional returns by investing the collateral in high-qual- 1. Although securities lending returns are relative- ity money market instruments (collateral reinvest- ly small, superior risk-adjusted performance ment).2 In this way, they capture reinvestment highlights its value. returns by assuming a limited degree of credit and 2. Managers may optimize their lending program through a broader framework that integrates the Figure 1 risk-return performance of the underlying Disaggregation of Securities Lending Returns investments. Increasingly, investors focus on minimizing Reinvestment return “frictional” losses due to management fees, commis- sions, and inefficient trading. A well-structured lend- Reinvestment spread ing program represents an attractive tool to offset Risk-free rate some of these losses. Demand spread An assessment of securities lending risks requires disaggregating program returns into two Rebate rate components: 1) demand, or “below-the-line,” spread; and 2) reinvestment, or “above-the-line,” spread. Depicted in Figure 1, this framework derives from the lending transaction. Typically, a prime broker (the borrower) provides cash collateral to borrow a security; the lender compensates the borrower by © 2006 by RMA. Ben Atkins, CFA, FRM, is a manager in the Corporate Initiatives Group, General Electric Company, in Fairfield, Connecticut; formerly, he was Asset- Liability manager at State Street Bank. Glenn Horner, CFA, FRM, PRM, oversees Portfolio Strategy and Quantitative Modeling for State Street’s Securities Finance Division. 42 The RMA Journal May 2006 Assessing Securities Lending Risk-Return Performance in a Portfolio Context Figure 2 Comparison of Risk Statistics Standard Deviation Skewness VaR4 Worst Excess Return Securities Lending Demand spreads 0.006% 0.7 0.01% 0.00% Reinvestment: overnight5 0.004 0.0 0.01 -0.01 Reinvestment: money market5 0.02 0.4 0.04 -0.05 Bond Indexes Lehman Brothers U.S. 1.29% -0.6 2.53% -4.23% Lehman Brothers U.S. Credit 1.35 -0.4 2.24 -4.36 Lehman Brothers Global Aggregate 1.68 0.3 2.70 -3.74 Stock Indexes S&P 500 4.73% -0.5 8.48% -14..90% Russell 2000 6.28 -0.5 8.93 -19.84 MSCI EAFE 4.56 -0.5 8.09 -12.97 Data period: monthly returns from 1/1/98 through 7/31/2005 (n = 91) Source: State Street SL PerformanceAnalyzer®, LehmanLive.com, Bloomberg, State Street analysis duration risk. Analyzing both of worst-return measures indi- fees, which can be 20-50 basis these return components reveals cate that securities lending points. On this scale, lending the relatively low levels of market resulted in minimal down- returns appear more substantial. risk in securities lending. side exposure compared to In a more rigorous approach, risk- We have studied 7.5 years of major benchmarks.6 adjusted return analysis quanti- lending data. During this period, This analysis highlights the large fies the risk-return trade-off. securities lending was consider- disparity between market risks in An analysis of risk-adjusted ably less risky than familiar mar- investment benchmarks and performance asks: Do returns ket indexes. Figure 2 compares securities lending. adequately compensate an risk data from State Street’s lend- A cynic may respond to investor for the level of portfolio ing program with several key Figure 2, by saying, “Yes, the risk? The Sharpe ratio addresses benchmark indexes.3 Several con- securities lending volatility is this question through a cost- clusions emerge: trivial, but so are the returns.” benefit approach: 1. The volatility of securities Some investment managers con- lending returns—the stan- clude that lending returns are dard deviation—was trivial immaterial compared to bench- Rp - rf compared to levels experi- mark returns, but the comparison S = ␴ enced in key benchmarks. is spurious. Active managers do p 2. The skew statistics show that not provide the benchmark extreme returns over the last return—they add value by seek- 7.5 years of lending tended ing alpha—incremental perform- With Rp the portfolio return, ␴ to be in excess of the mean, ance in excess of the rf the risk-free rate, and p the while extremes in bench- benchmark.7 Top managers deliv- standard deviation of portfolio mark returns tended to be er 100-400 basis points of alpha. returns; this ratio may be inter- unfavorable. Similarly, passive managers preted as the excess return pro- 3. The value-at-risk (VaR) and emphasize low tracking error and vided for each unit of volatility.8 43 Figure 3 Analysis of RIsk-Adjusted Performance Mean Excess Return (annualized) Sharpe ratio Securities Lending Demand spreads 0.21% 10.1 Reinvestment: overnight 0.02 1.6 Reinvestment: money market 0.24 2.8 Bond Indexes Lehman Brothers U.S. Govt 2.47% 0.6 Lehman Brothers U.S. Credit 3.05 0.7 Lehman Brothers Global Aggregate 2.45 0.4 Stock Indexes S&P 500 1.19% 0.1 Russell 2000 3.75 0.2 MSCI EAFE -0.28 0.0 Data period: monthly returns from 1/1/98 through 7/31/2005 (n = 91) Source: State Street SL PerformanceAnalyzer®, LehmanLive.com, Bloomberg, State Street analysis Figure 3 provides a key finding: 3. The money market reinvest- this finding should further reduce Lending returns were smaller than ment strategy drives superior concerns about securities lending market index returns, but lending risk-adjusted performance by market risk. If, for example, an offered superior risk-adjusted per- capturing additional returns investor suffers losses from a formance over this time period. through modest exposure to Russell 2000 portfolio, lending Both sources of securities duration and credit risk. does not amplify these losses. lending returns—demand and On a stand-alone basis, the Over time, lending returns offer a reinvestment spreads—contribute demand and reinvestment spreads small dampening effect for overall to this conclusion. Taking each represent a compelling source of volatility. component in turn: low-risk, incremental returns. Construction of an efficient 1. The high Sharpe ratio for Securities lending also performs frontier offers a useful synthesis of below-the-line returns stems well when viewed within a broad- the benefits of securities lend- from borrowers’ stable demand er portfolio context. ing—low-risk incremental returns for securities. As one invest- Specifically, correlation analy- with low correlation to investors’ ment manager remarked, sis demonstrates that lending portfolios. Figure 5 shows how “The demand spread looks returns provide modest diversifi- lending returns have expanded like a free lunch.” cation by exhibiting zero correlation the efficient frontier.9 The lower 2. The overnight reinvestment to benchmarks. Figure 4 provides frontier depicts, for a given level strategy achieves a favorable the correlation coefficients for the of volatility, the maximum excess Sharpe ratio by earning a components of lending returns monthly return earned with the small, nearly fixed spread by with the returns from a composite optimal allocation across asset assuming incremental credit index of underlying lendable classes. Using typical on-loan uti- risk on the collateral. Speci- assets. A correlation less than 1.00 lization levels, the higher frontier fically, reverse Treasury repo leads to a reduction in the overall shows that lending increases sets the risk-free rate, and the portfolio’s volatility. This effect monthly returns by 0.5-1.5 basis 2-basis-point spread repre- increases as the correlation falls to ponits across a range of alloca- sents a weighted average of zero; correlations less than zero tions.10 Lending improves the repo spreads for lower grades indicate that returns tend to vary efficient frontier by consistently of collateral (e.g., agencies, inversely with the underlying adding incremental returns, while mortgage-backed securities). portfolio. The effect is small, but reducing the volatility of the over- 44 The RMA Journal May 2006 Figure 4 Correlations of Returns from Lending and Underlying Portfolios Reinvest Spread— Demand Spread Reinvest Spread—Overnight Composite of Client Assets Short-term Demand Spread 1.00 Reinvest Spread—Overnight (0.48) 1.00 Reinvest Spread— (0.12) 0.03 1.00 Short-term Composite of Client Assets 0.05 (0.01) (0.10) 1.00 Note 1: Composite of client assets represents the asset-weighted returns from the Lehman Brothers US, Europe, and Asia bond indexes; MSCI North America, Europe, and Asia Pacific equity indexes Note 3: Correlation uses monthly returns from 1/1/98 through 7/31/2005 (n = 91, DF = 89) Source: State Street SL PerformanceAnalyzer®, LehmanLive.com, Bloomberg, State Street analysis all portfolio. Graphically, the adjusted performance. opposite strategy of the Overnight Sharpe ratio is the slope of the Figure 6 outlines several column. Investors with high risk line from the origin to the risk- approaches to developing a col- tolerance lend securities to return point on the graph. lateral reinvestment strategy. A finance purchases to replicate the Lending steepens this line by program that restricts collateral exposures of the underlying port- shifting the endpoint up and to reinvestment to overnight repo folio.
Load more

Recommended publications
  • Understanding and Managing Risk in Public Investing
    CDIAC/CMTA Advanced Public Funds Investing Workshop Session Three: Understanding and Managing Risk in Public Investing Presented by: Sarah Meacham, Managing Director January 15, 2020 PFM Asset 601 S. Figueroa Street, Suite 4500 Management LLC Los Angeles, CA 90017 www.pfm.com 213.489.4075 © PFM 1 TYPES OF FIXED INCOME INVESTMENT RISK Inflation Interest rate Topics Liquidity Reinvestment Credit HOW TO MANAGE AND MITIGATE RISK Investment policy development Diversification Discipline to long-term strategy Performance measurement © PFM 2 “Risk is inherent throughout the investment process. There is investment risk associated with any investment activity and opportunity risk related to inactivity.” ~Local Agency Investment Guidelines, CDIAC January 1, 2019 © PFM 3 Types of Fixed Income Investment Risk © PFM 4 Types of Fixed Income Investment Risk Inflation Risk Liquidity Risk Credit Risk Loss of purchasing Inability to sell portfolio Risk of default or power over time as a holdings at a competitive decline in security value result of inflation price due to issuer’s financial strength Reinvestment Risk Interest Rate Risk The risk that a security’s Variability of return/price cash flow will be related to changes in reinvested at a lower interest rates rate of return © PFM 5 Inflation Risk © PFM 6 Inflation (Purchasing Power) Risk Loss of purchasing power over time as a result of inflation Real interest rate is after inflation; nominal is before inflation • Real = nominal – inflation • Nominal = real + inflation • Inflation = nominal
    [Show full text]
  • Property/Liability Insurance Risk Management and Securitization
    PROPERTY/LIABILITY INSURANCE RISK MANAGEMENT AND SECURITIZATION Biography Trent R. Vaughn, FCAS, MAAA, is Vice President of Actuarial/Pricing at GRE Insurance Group in Keene, NH. Mr. Vaughn is a 1990 graduate of Central College in Pella, Iowa. He is also the author of a recent Proceedings paper and has been a member of the CAS Examination Committee since 1996. Acknowledgments The author would like to thank an anonymous reviewer from the CAS Continuing Education Committee for his or her helpful comments. PROPERTY/LIABILITY INSURANCE RISK MANAGEMENT AND SECURITIZATION Abstract This paper presents a comprehensive framework for property/liability insurance risk management and securitization. Section 2 presents a rationale for P/L insurance risk management. Sections 3 through 6 describe and evaluate the four categories of P/L insurance risk management techniques: (1) maintaining internal capital within the organization, (2) managing asset risk, (3) managing underwriting risk, and (4) managing the covariance between asset and liability returns. Securitization is specifically discussed as a potential method of managing underwriting risk. Lastly, Section 7 outlines four key guidelines for cost- effective risk management. 1. INTRODUCTION In recent years, the property-liability insurance industry has witnessed intense competition from alternative risk management techniques, such as large deductibles and retentions, risk retention groups, and captive insurance companies. Moreover, the next decade promises to bring additional competition from new players in the P/L insurance industry, including commercial banks and securities firms. In order to survive in this competitive new landscape, P/L insurers must manage total risk in a cost-efficient manner. This paper provides a rationale for P/L insurance risk management, then describes four categories of risk management techniques utilized by insurers.
    [Show full text]
  • Diversification and Discussion of Risk
    Diversification and Discussion of Risk Conference of the County Investment Academy San Antonio June 2019 PFIA 2256.008c Requires Training in: • Investment Diversification 2 Capital Market Theory 12.0% 10.0% 8.0% E( r) 6.0% P* * 4.0% 2.0% 0.0% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% Std. Dev. 3 Capital Market Theory • Points along the upper half of the curve represent the best risk/return diversified portfolios of risky assets • The straight line represents portfolios obtained by investing in the “optimal risky portfolio” (P*) and either lending or leveraging at the “risk‐free” rate. • Points on the line below the curve represent “lending” and points above represent “leveraging” (note increased “risk” as measured by standard deviation of returns!) 4 So in theory….. Key result? An undiversified portfolio yields inferior return for the level of risk! The same, or higher, return could be attained at a lower level of risk with a diversified portfolio. If you are not diversified, you are taking more risk than you can expect to be compensated for! 5 Diversification and Correlation of Returns Correlation, which measures the degree of “co‐ movement”, ranges from ‐1 to +1. When the correlation between returns is less than 1 there are diversification benefits—the risk of portfolio is less than the average of the risks of the individual assets. Which pair of stock returns is more correlated? Chevron, Exxon Chevron, Delta Airlines 6 International Diversification Correlations vs S&P 500: China 0.62 Korea 0.53 Japan 0.73 Germany 0.74 UK 0.73 Brazil 0.29 Chile 0.38 Monthly returns vs corresponding MSCI indexes (US dollar returns) 5 years ended April 2019 Source: FactSet 7 Global Market Capitalization Latin Canada 1% UK 3% Other 5% 1% Japan 8% Asia ex Japan 13% U.S.
    [Show full text]
  • Securities Loans Collateralized by Cash: Reinvestment Risk, Run Risk
    Securities Loans Collateralized by Cash: Reinvestment Risk, Run Risk, and Incentive Issues Frank M. Keane Securities loans collateralized by cash are by far the most popular form of securities-lending transaction. But when the www.newyorkfed.org/research/current_issues F cash collateral associated with these transactions is actively reinvested by a lender’s agent, potential risks emerge. This 2013 F study argues that the standard compensation scheme for securities-lending agents, which typically provides for agents to share in gains but not losses, creates incentives for them to take excessive risk. It also highlights the need for greater scrutiny and understanding of cash reinvestment practices— especially in light of the AIG experience, which showed that Volume 19, Number 3 Volume risks related to cash reinvestment, by even a single participant, could have destabilizing effects. lthough less researched than the money markets, the collateral markets IN ECONOMICS AND FINANCE are critical to the efficiency of the asset markets—including the markets for ATreasury, agency, and agency mortgage-backed securities. Well-functioning collateral markets allow dealers and investors in the asset markets to finance short positions for the purposes of hedging, market making, settlement, and arbitrage. Two important mechanisms for accessing the U.S. money and collateral markets are repurchase agreements (repos) and securities-lending transactions. In a money market transaction, when cash and securities are exchanged, the securities act as collateral and mitigate the risks associated with a borrower’s failure to repay the cash. In a collateral market transaction, however, the cash serves as collateral and mitigates the risk associated with replacing the security if the borrower fails to return it.
    [Show full text]
  • Interest Rate Risk • Interest Rate Risk Is the Risk Market Rates Will Change. O
    MANAGING BOND PORTFOLIOS Interest Rate Risk Interest rate risk is the risk market rates will change. o Price risk—bond prices (values) move opposite interest rates; there exists an inverse relationship such that prices decrease when market rates increase, and vice versa. o Reinvestment risk—interest rate changes are positively related to the ability to reinvest at favorable rates; that is, when market rates increase, the coupon interest that is paid by a bond can be reinvested at higher rates, and vice versa. Interest rate sensitivity—the characteristics of bonds indicate how sensitive bond prices are to changes in interest rates. o Bond prices move opposite changes in interest rates (inversely related). When market yields increase, bond price decrease, and vice versa. A price decrease that results from an increase in the market rate will be less than a price increase that results from an equivalent decrease in the market rate. o Everything else equal, bond prices are more sensitive for bonds with: . Longer terms to maturity than bonds with shorter terms to maturity. The sensitivity of longer-term bonds increases at a decreasing rate, which means that a bond with 20 years to maturity is not twice as sensitive to changes in market rates than a bond with 10 years to maturity; e.g., the price of a 10-year bond might decrease by 6 percent when market rates increase, whereas the price of the 20- year bond would decrease by 9 percent for the same change in market rates. Bonds with lower coupon rates than bonds with higher coupon rates.
    [Show full text]
  • Blackrock Securities Lending
    BlackRock Securities Lending Unlocking the potential of portfolios January 2021 | Securities Lending Introduction: In summary: Securities lending is a well-established practice whereby • While not without risk, securities lending seeks to U.S. registered funds, such as mutual funds, make loans benefit the fund. of securities to seek an incremental increase in returns for • BlackRock has focused on delivering competitive fund shareholders. returns while balancing return, risk and cost in its three This paper explains the basics of securities lending, decades of lending securities on behalf of outlines the benefits and risks for investors, and describes shareholders. BlackRock’s leading approach to securities lending. • Since 1981, BlackRock has delivered positive monthly lending income for every fund that has participated in Basics of Securities Lending securities lending, including mutual funds. In securities lending transactions, mutual funds lend stocks or bonds to generate additional returns for Benefits of Securities Lending the funds. Mutual fund investors can benefit from securities lending Here’s how it works: first, a large financial institution asks in the form of fund performance. How? The mutual fund to borrow a stock or bond from a mutual fund. In order to seeks to generate additional income through the rate that borrow the stock or bond, the financial institution will it charges for lending securities (if applicable), and/or income on the reinvestment of the collateral that the negotiate financial terms with the lending agent of the borrower provides in exchange for the loan. mutual fund and provide collateral. The mutual fund keeps the collateral to secure repayment in case the Securities lending returns typically vary by asset class and borrower fails to return the loaned stock or bond.
    [Show full text]
  • Asset Securitisation
    Superseded document Basel Committee on Banking Supervision Consultative Document Asset Securitisation Supporting Document to the New Basel Capital Accord Issued for comment by 31 May 2001 January 2001 Superseded document Superseded document Table of Contents OVERVIEW .............................................................................................................................................1 I. THE TREATMENT OF EXPLICIT RISKS ASSOCIATED WITH TRADITIONAL SECURITISATION........................................................................................................................1 A. THE STANDARDISED APPROACH .............................................................................................2 1. The treatment for originating banks..........................................................................2 (a) Minimum operational requirements for achieving a clean break.................................3 (b) Minimum capital requirements for credit enhancements ............................................3 (c) Minimum operational requirements for revolving securitisations with early amortisation features .............................................................................................................4 2. The treatment for investing banks ............................................................................6 (a) Minimum capital requirements for investments in ABS...............................................6 (b) Treatment of unrated securitisations ..........................................................................7
    [Show full text]
  • Chapter 4 Interest Rate Measurement and Behavior Chapter 5 the Risk and Term Structure of Interest Rates
    Chapter 4 Interest Rate Measurement and Behavior Chapter 5 The Risk and Term Structure of Interest Rates LEVEL OF INTEREST RATES Fisher Effect (risk-free rate) Interest rate has 2 components: (1) real rate (2) inflation premium I = r+ IP STRUCTURE OF INTEREST RATES http://www.ratecurve.com/yc2.html Term Structure of Interest Rates - defines the relationship between maturity & annualized yield, holding other factors such as risk, taxes, etc., constant. Graphic presentation is the yield curve. Curve shifts and twists through time. Four Basic Shapes: Positive Yield Curve: upward sloping Negative Yield Curve: downward sloping Flat Yield Curve Humped Yield Curve Level of Interest Rates: Loanable Funds Theory -- market interest rate is determined by the factors that control the supply of and demand for loanable funds. Demand Factors Household: Y increases then installment debt increases R increases then installment debt falls Business: n CFt NPV = - I + å (1+i )t T =1 if i decrease _ NPV (?) Government: interest inelastic 1980: debt/GNP =25% 1987: debt/GNP=42% Foreign Foreign interest rates vs. U.S. rates Supply Households - largest suppliers Very steep slope for supply. Why? What happens if expect higher inflation? Savers - Liquidity Preference Theory - Market rate of interest is determined by demand/supply of money balances. Demand of Money + Transaction f(y) + Precautionary f(y) - Speculative f(r) Supply of Money Fed basically determines supply Few uncontrollable factors (1) banks lending (2) public's preference for cash Letting D=S then solve for interest rate: + + - _ r = f ( , , ) y m p e THEORIES ON SHAPE OF YIELD CURVE Unbiased Expectations - shape of yield curve is determined solely by current & expected future short-term interest rates.
    [Show full text]
  • Reviewing Systemic Risk Within the Insurance Industry
    Reviewing Systemic Risk within the Insurance Industry February 2017 2 Reviewing Systemic Risk within the Insurance Industry SPONSOR Society of Actuaries AUTHOR Max J. Rudolph, FSA, CERA, CFA, MAAA Caveat and Disclaimer The opinions expressed and conclusions reached by the authors are their own and do not represent any official position or opinion of the Society of Actuaries or its members. The Society of Actuaries makes no representation or warranty to the accuracy of the information. Copyright ©2017 All rights reserved by the Society of Actuaries © 2017 Society of Actuaries 3 TABLE OF CONTENTS Executive Summary .................................................................................................................................................. 4 Systemic Risk ............................................................................................................................................................ 5 Systemic Risk Definition ............................................................................................................................................. 5 Definition Nuances ..................................................................................................................................................... 7 What are the Drivers of Systemic Risk? ................................................................................................................... 10 Size ..............................................................................................................................................................
    [Show full text]
  • Interest Rate Risk # Reinvestment Risk: the Returns on Funds to Be Reinvested Will Fall Below the Cost of Funds
    Interest Rate Risk # Reinvestment risk: the returns on funds to be reinvested will fall below the cost of funds. # Refinancing risk: the costs of rolling over funds or reborrowing funds will rise above the returns generated on investments. # Int rate risk is the risk incurred by an FI if it mismatches the maturities of it’s A & L. # Market value risk: Interest rate increase, the market value of assets and liabilities decrease Credit risk is é possibility that promised cash flows may not occur or may only partially occur. 2 types of credit risk: 1. Systematic credit risk affects all borrowers. 2. Firm-specific credit risk affects a particular company. NB:Firm-specific credit risk can be managed through diversification. (b) Which types of FIs are more susceptible to this type of risk? Why? Answer: FIs that lend money for long periods of time, whether as loans or by buying bonds, are more susceptible to this risk than those FIs that have short investment horizons. ‐ Maturity Model •MA–ML > 0: the FI is exposed to increasing interest rates. R asset decrease more •MA– ML < 0: the FI is exposed to decreasing interest rates. R liability decrease more •MA– ML = 0: the FI is ‘immunised’. For most FIs: MA– ML > 0. Maturity matching does not always eliminate interest rate risk exposure, because: a. The duration of A & L might be different, b. The maturity model does not consider the leverage of the FI ‐ Duration Model Duration and maturity: dD/dM>0 Duration and yield: dD/dR< 0 Duration and coupon interest rate: dD/dC< 0 Foreign Exchange Risk Foreign exchange risk: The risk that changes in exchange rates can affect the value of an FI’s Asset and/or Liabilities located abroad.
    [Show full text]
  • Investment Risk: What Risks Are You Willing to Take? Compound Value Advisers by Jerry Matecun
    Investment Risk: What Risks Are You Willing to Take? Compound Value Advisers by Jerry Matecun Stocks For the Long-Term….What About Your Term? The first reaction to the chart below is – a no-brainer – stocks compound at a much higher rate than bonds and inflation; therefore, put your money in stocks for the long-term! Yet we know that in the last 15 years we have seen two investment booms that went bust in a very short time period. Stocks declined over 50% in 18 months; there have been several longer term stock declines throughout history. Statistical certainty of future returns does not exist, and this presents a challenge to managing portfolio risk. Time horizon is a key element to consider. A younger person with a long time horizon can better handle this type of market risk. However, as you near retirement age, this kind of decline can cause very real anxiety. Understanding the relationship between the various risk and rates of return inherent in every asset class is fundamental to constructing an investment plan that can help you sleep at night. Ibbotson® SBBI® Stocks, Bonds, Bills, and Inflation 1926–2012 $18,365 $10,000 $3,533 Compound annual return 1,000 • Small stocks 11.9 % • Large stocks 9.8 • Government bonds 5.7 • Treasury bills 3.5 • Inflation 3.0 $123 100 $21 $13 10 1 0.10 1926 1936 1946 1956 1966 1976 1986 1996 2006 Past performance is no guarantee of future results. Hypothetical value of $1 invested at the beginning of 1926. Assumes reinvestment of income and no transaction costs or taxes.
    [Show full text]
  • Financial Instruments Risks
    Financial Instruments Risks Market Risk Market Risk, also known as “undiversifiable risk,” “volatility” or “systematic risk,” affects the overall market or a broad sector, not just a particular financial instrument or company, and it cannot be mitigated through diversification. It is the risk of an adverse change of price of a portfolio or an asset as a result of changes in the entire market or an entire market segment. Credit Risk The risk of loss of principal or loss of a financial reward stemming from an issuer’s failure to repay any type of debt, or meet a contractual obligation. In bond markets credit risk relates to: (a) the price fall due to increased credit risk of the issuer (increased credit spreads, decreased credit ratings, etc), (b) the risk that the issuer will not fulfill its obligations, such as coupon and principal payment for any reason, including bankruptcy or other insolvency proceedings. This risk is higher in the emerging markets and in securities with low credit rating (below investment grade). Interest rate risk Refers to changes in the yield of an investment due to interest rate fluctuations. A shift in the yield curve would result in a change in a bond’s price. If the level of yields / yield curve is higher than it was at the time of initial investment, early liquidation in these securities will be realized at a price lower than the price of the initial investment. This risk is higher in emerging markets and in high yield bonds. Liquidity Risk The risk that a given security or asset cannot be traded quickly enough in the market, due to the lack of marketability to prevent or minimize a loss (or make the required profit).
    [Show full text]