Quick Answer
Systematic risk hits the whole market and cannot be diversified away; nonsystematic risk is company-specific and can be. Returns split into return of capital, tax-exempt interest, taxable income, and total return. Firms must disclose material facts and can place a temporary hold to protect specified adults from suspected financial exploitation.
The whole unit on one sheet: what can go wrong, what investors earn, what must be disclosed, what it costs, and how firms shield vulnerable investors.
How Do Systematic and Nonsystematic Risk Differ?
- Systematic (market) risk: affects the entire market; non-diversifiable. Mitigate only through hedging or asset allocation. Beta measures sensitivity to it.
- Systematic types: market, interest-rate (rising rates cut existing bond values), inflation (purchasing-power) (erodes fixed payments), currency (exchange-rate) (foreign FX moves), and reinvestment (falling rates force cash flows to reinvest at lower rates).
- Nonsystematic (diversifiable) risk: specific to a company, industry, or sector; can be reduced through diversification.
- Nonsystematic types: business (operations/management), financial (leverage/default), credit (default) (issuer misses payments), event (merger, disaster, fraud scandal), and regulatory/legislative (political) (government action on a specific company, industry, or country).
Which One-Liners Win Points?
- Systematic cannot be diversified away; nonsystematic can. The risk diversification eliminates is always nonsystematic, never market risk.
- Zero-coupon bonds: maximum interest-rate risk, zero reinvestment risk. High-coupon callable bonds: the reverse.
- Interest-rate risk and reinvestment risk pull opposite ways: rates up hurts existing bonds, rates down hurts reinvesting cash flows.
- Falling rates = prepayment risk; rising rates = extension risk (mortgage-backed securities and collateralized mortgage obligations).
- Return of capital is not income; it reduces cost basis, and once basis hits zero the rest is a capital gain.
- Treasury interest is exempt from state and local tax but not federal; municipal interest is the opposite.
- Total return = income plus price change, over the initial investment; unrealized gains count.
- The Statement of Additional Information (SAI) is delivered only on request; the prospectus is delivered.
Which Numbers Matter Most?
| Item | Value |
|---|---|
| Qualified-dividend holding period | more than 60 days within the 121-day window around the ex-dividend date |
| Short-term vs. long-term capital gain line | held 1 year or less = short-term (ordinary income) |
| Front-end load (Class A) | typically 3% to 5.75% |
| 12b-1 fee cap | 1.00% (up to 0.75% distribution, up to 0.25% service) |
| No-load 12b-1 ceiling | 0.25% or less |
| Surrender period / penalty-free withdrawal | 6 to 8 years / up to 10% of account value per year |
| Mortality and expense (M&E) charge | 1.00% to 1.50% per year |
| Letter of Intent window | 13 months |
| Specified adult age | 65 or older, or 18 or older and impaired |
| Temporary hold: initial / with extension / with state reporting | 15 / 25 / up to 55 business days |
What Is the Memory Aid for the Systematic Risks (PRIME)?
- Purchasing power (inflation) risk
- Reinvestment risk
- Interest rate risk
- Market risk
- Exchange rate (currency) risk
Which Gotchas Trip Students Up?
- Tax-equivalent yield = municipal yield / (1 minus marginal tax rate). The higher the bracket, the more attractive the muni; private-activity-bond interest may trigger the alternative minimum tax (AMT).
- The 5% policy is a guideline, not a cap, and it does not apply to mutual funds, variable annuities, new issues at a fixed price, or municipal securities.
- Breakpoint selling is a violation: a purchase just under a breakpoint must be flagged; splitting orders to dodge the discount breaks the rules.
- Soft dollars pay only for research and brokerage services. Rent, travel, entertainment, hardware, and personal costs never qualify.
- A control relationship must be disclosed before or at the time of the transaction, not after.
- The temporary hold covers both disbursements and securities transactions, applies only to the suspect item (not the whole account), and only supervisory, compliance, or legal personnel may authorize it.
- A trusted contact person has no authority over the account and the customer may decline to name one.
One-Breath Recap
Sort risk into systematic (whole-market, non-diversifiable, remember PRIME) and nonsystematic (company-specific, diversifiable), then match returns to their tax treatment, from return of capital to total return. Disclose every material fact, know the fee layers that eat returns, and remember the temporary-hold clock (15, then 25, then up to 55 business days) that protects specified adults. Nail those and this unit answers itself.
Need more than the recap? Read the full Investment Risks and Returns unit.