Friday, October 31, 2008


Exchange rate or Currency Risk.
A non dollar-denominated bond (i.e. a bond whose payments occur in a forign currency) has unknown US doller cash flows.The dollar cash flow are dependent on the forign-exchange rate at the time payments are recived.For example Suppose & invester purchases a bond whose payments are in Japanese yen depreciates relative to the US doller,than fewer doller will be recived.The risk of this occurring is referred to as exchange rate risk of course,shoud the yen appreciate relative to the US doller the invester will benifit by receiveing more dollers.
For example ,if a US invester purchase German goverment bonds denominated in deutsche market,the proceeds received from the sale of that bond prior to maturity will depends on the level of interest rates in the German bonds market,in addition to the exchange rate.
Valatility Risk.
The price of a bond with an embedded option depends on the level of interest rates & factor that influence the value of the embedded option.One of the factor is the expected volatility of interest rates Specifically the value of an option rises when expected interest rate volatility increase.In the case of a callable bond or mortgage banked security.Because the invester has granted an option to the borrower,the price of the security falls because the invester has given away a more valuable option.The risk is that change in volatility will aversely affect the price of a security is called volatility risk.

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