Banking Terms - Set 15 (Exchage rate risk, Inflation risk & Put provision on bond, Unsystematic risk, Call premium)

Call premium

Premium in price above the par value of a bond or share of preferred stock that must be paid to holders to redeem the bond or share of preferred stock before its scheduled maturity date.

Put Provision on Bond

A put provision grants the bondholder the right to sell the issue back to the issuer at par value on designated dates. Here the advantage to the investor is that if interest rates rise after the issue date, thereby reducing a bond’s price, the investor can force the issuer to redeem the bond at par value.

Unsystematic risk

It is also called as the diversifiable risk or residual risk. The risk that is unique to a company such as a strike, the outcome of unfavorable litigation, or a natural catastrophe that can be eliminated through diversification.

Inflation risk on bonds

If investors purchase a bond on which they can realize a coupon rate of 5% but the rate of inflation is 6%, the purchasing power of the cash flow actually has declined. Inflation risk arises because of the variation in the value of cash flows from a security due to inflation, as measured in terms of purchasing Power.

Exchange-rate risk on bonds

A non-domestic-currency nominated bond has unknown domestic currency cash flows. The domestic currency cash flows are dependent on the exchange rate at the time the payments are received.

For example, suppose that a German investor purchases a bond whose payments are in British pounds (GBP). If pounds depreciate relative to euros (EUR), fewer euros will be received and vice versa. This risk is also referred to currency risk.