Idiosyncratic and systemic risk.
Chapter 19 primary question: Explain how exchange rates and interest rates are linked (including the mechanisms for that linkage.)
Chapter 20 primary question: Why and when was the velocity of money stable and why and when was it unstable?
Chapter 21 primary question: Fully develop the AD/AS model with inflation and output as its axis labels in both the short run and long run. Be sure to include all of the elements that go into its development.
Chapter 22 primary question: Describe the Great Moderation, when and how it came about and why it ended as badly as it did.
Chapter 23 primary question: Summarize all of the channels by which the monetary policy transmission mechanism can work.
example of a really good answer:
Distinguish between idiosyncratic and systemic risk.
Idiosyncratic risk is the risk that results from owning a specific security in the form of a stock, bond, CD, etc. It is the risk you think of when you think about losing money investing in a specific thing. For example, if you bought a share of AMZN, and then earnings came out and they were disappointing and the stock price falls resulting in you losing money, you just suffered the consequences of idiosyncratic risk. You can diversify against idiosyncratic risk by purchasing many different securities so that when one does poorly, it doesn’t affect you as much because the others are likely to not be suffering the same problems.
Systemic risk, on the other hand, is risk that affects many securities at once. These are often geopolitical events that result in the market as a whole being affected. For example, a highly infectious virus might originate somewhere in the world and start to spread aggressively causing economic slowdowns/lockdowns that in turn affect the performance of many securities at once. These sorts of things are generally out of the hands of individual investors, and cannot be so easily diversified against.
You might look at it this way. You’re on a ship in the middle of the ocean. There are things you can do to make sure you don’t fall off of the ship. You can avoid the top deck, wear a restraint of some sort, make sure people are keeping track of you, etc.. Here, you are doing what you can as an individual to manage the idiosyncratic risk of falling of the ship. However, if the ship is sinking, that might be out of your hands. Now you have the systemic risk (the sinking ship) that you cant do much about. This will affect all of the passengers (securities) at once, and diversification (risk management) will not have helped that much.
Sample Solution
In addition to macroeconomic factors such as interest rates and inflation, the currency exchange rate is one of the most important determinants of a country’s relative level of economic health. A strong currency renders a country’s imports less expensive and its exports more expensive in foreign markets. Exchange rates are relative and are expressed as a comparison of the currencies of two countries. Numerous factors determine exchange rates. Many of these factors are related to the trading relationship between the two countries. It should be noted that exchange rates are relative, and are expressed as a comparison of the currencies of two countries.
