What type of investments are most at risk for losing value due to inflation quizlet?

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Interest-rate risk primarily affects existing bondholders, since the market value of their investments will decline if interest rates rise.
If rates do rise, new potential investors will not be interested in purchasing existing bonds at par ($1,000) due to the fact that they can obtain higher yields by purchasing newly issued bonds with higher coupon rates. For that reason, the prices of existing bonds will need to be lowered to attract purchasers.
diversification: Diversification doesn't help with non-diversifiable risk. A diversified portfolio of bonds from different issuers with different coupon rates, maturity dates, and geographic locations will provide protection against some risks, but NOT against interest-rate risk.
In other words, since all bonds have some exposure to interest-rate risk, it's considered systematic or non-diversifiable.
duration: Bonds with longer maturities tend to be more vulnerable to interest-rate risk than bonds with shorter maturities. Also, bonds with lower interest rates are more sensitive to interest-rate risk than bonds with similar maturities and higher coupon rates. Duration measures the sensitivity of a bond or portfolio of bonds to a given change in interest rates. Duration is measured in years, but for practical purposes, a bond's change in price is based on its duration.
--For example, if a bond's duration is 10 years, a 1% increase in interest rates will cause a 10% decrease in the bond's price. Some investors will spread out (ladder) their bond maturities to minimize the impact of interest-rate risk by having a portion of their holdings in shorter term bonds.
Interest rates and equities: Stock prices may also be influenced by interest rate changes. For example, when interest rates are rising, utilities stocks will be adversely affected because these companies are heavy borrowers (leveraged). However, stocks of cosmetic companies (defensive stocks) are not as affected by rising interest rates, which is due to the nature of their business and the low cost of their products.
If interest rates rise, preferred stocks will react in a manner that's similar to debt securities. In other words, preferred stock prices have an inverse relationship to interest rate changes.

Inflation (purchasing-power) risk is experienced by investments that provide fixed payments (e.g., bonds and fixed annuities). Inflation is the rising price levels of goods and services as measured by the Consumer Price Index (CPI). Ultimately, inflation diminishes the real value of a dollar by decreasing its purchasing power.
Historically, equity securities, variable annuities, investments in real estate, or precious metals (e.g., gold and silver) have provided the best protection against inflation.
Inflation hurts bondholders in two ways, 1) inflation leads to rising interest rates which causes the market prices of their existing bonds to fall, and 2) the purchasing power of their interest payments decreases.
As stated previously, many market professionals measure an investment's real rate of return (for bonds, it's also referred to as the real interest rate). The formula for calculating real rate or return is an investment's return minus the rate of inflation (as measured by the Consumer Price Index, or CPI). For example, if an investment has an 8% return and CPI is 3%, the real rate of return is 5%.

In contrast to systematic risk, unsystematic risk is based on circumstances that are unique to a specific security and may be managed by diversifying the assets in a portfolio (i.e., by selecting stocks possessing different risk-return characteristics).
The following are different types of unsystematic risk: business risk, regulatory risk, legislative risk, political risk, liquidity risk, opportunity (cost) risk, reinvestment risk, currency (exchange-rate) risk, capital risk, credit risk, call risk, prepayment risk

Portfolio rebalancing involves a process of buying and selling assets on a periodic basis.
Through rebalancing, the original strategic asset allocation—and its risk/reward characteristics—may be restored. With this approach, adjustments may be based on either time or valuelue*.
If time is used as the focus, portfolio rebalancing may be done based on a prearranged schedule (e.g., monthly, quarterly, or annually).
On the other hand, if adjustments are triggered by value change, the need to rebalance is based on an asset class growing or shrinking beyond a set tolerance level from the original allocation (e.g., ±10%).
More frequent rebalancing will keep a client's portfolio closer to its strategic allocation. However, more frequent rebalancing will result in higher transaction costs as some assets are sold and others are purchased.
Both the buy-and-hold and systematic rebalancing approaches assume that markets are efficient.
Or, to put another way, it's impossible to time changes in asset balances to take advantage of market movements. These passive approaches to asset allocation are in agreement with the market theory which is referred to as the Efficient (Capital) Market Hypothesis.

Sector rotation is an investment strategy that involves moving money from one industry or sector to another in an attempt to beat the market. Since not all sectors of the economy perform well at the same time, this method of asset allocation may allow investors to profit as the economy moves from one cycle to another.
The business (economic) cycle follows a certain pattern—early recession, full recession, early recovery, and full recovery. Although the length and severity of any of these stages may vary, this is the general pattern. Certain sectors of the economy tend to do better than others during different stages in the business cyclee*.
For example, during the early part of a recession, utilities tend to perform well, while airlines tend to do badly since people have less discretionary income to spend on travel.
A portfolio manager who employs a sector rotation strategy will try to anticipate the next turn in the business cycle and shift assets to the sectors that will derive the most benefit.
Therefore, if the manager believes that a recession is near its end and the economy is entering the recovery period, she would begin shifting funds to the sectors that would profit the most from the change, such as companies that make durable consumer goods (e.g., automobiles, appliances, etc.).

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