Question

Drag each tile to the correct box.

Answer 1

Answer:

1. Reinvestment risk ⟶ George purchased a US Treasury bond that matures in five years. He plans to purchase a newly issued Treasury bond and hopes it will be just as valuable.
2. Inflationary risk ⟶ Claretta purchased a Treasury bond that pays 1% interest when the price of goods and services are rising by 2%.
3. Credit risk ⟶ Corbin purchased a corporate bond with a poor rating and a risk of default.
4. Market risk ⟶ Beth bought a company’s stock in hopes of a quick profit, but the stock price has been very unpredictable.

Explanation:

1. Let's review the first scenario. We know that George just bought a bond that will mature in five years. If the bond turns out to be profitable, he intends to buy a new US Treasury bond once his current one matures. This accurately describes a reinvestment risk because he is risking buying a second bond based on the outcome of the first one. Once the bond matures, the interest rates will have fallen, which will make it extremely less likely that newer bonds available to reinvest in will offer the same rewards.
2. Now take a look at the scenario. This one is relatively obvious. Since it states that the prices of goods and services are rising, Claretta's interest won't seem like much after a few years. This makes it an inflationary risk because the inflation rates in her country are rising and her interest returned will buy her less that it would have in the past.
3. Moving onto the third scenario, we can see that Corbin purchased a bond from a corporation that has incredibly low ratings and usually fails to repay their loans. This indicates a credit risk. A credit risk occurs when  an investor chooses to invest in a bond issuer that has a history of poor credit reliability. This is clearly the case for this issue and therefore, Corbin has made a credit risk.
4. The final scenario indicates a market risk. A market risk is any factor that affects the overall performance of the financial markets. Since the stock prices in Beth's economy have been unpredictable, clearly something has negatively impacted the market so the stock prices are frequently fluctuating.