Investment risk may be defined as the chance that an investment’s actual return may differ from the expected return. Risk means you have the possibility of losing some, or even all, of your original investment. In simple words, investment risks mean the possibility of losing the money that one might have invested.
TYPES OF INVESTMENT RISKS
- SYSTEMATIC RISK:
Systematic (market) risk is the uncertainty in a security’s total returns that are directly associated with over-all movements in the general market or economy. Interest rates, recession, and wars all are the sources of systematic risk because they affect the entire market and cannot be avoided through diversification. It is a non-diversifiable risk. Systematic risk can be avoided only by hedging. Beta (β) is the measure of systematic risk.
- UNSYSTEMATIC RISK:
Unsystematic risk is the uncertainty in the variability in security’s total returns not related to the overall market variability. This risk is unique to a particular security. It can be reduced through diversification. For example, news that is specific to a small number of stocks, such as a sudden strike by the employees of a company you have shares in, is considered to be an unsystematic risk.
- LIQUIDITY RISK:
Liquidity risk refers to the possibility that an investor may not be able to buy or sell an investment as and when desired or in sufficient quantities because opportunities are limited. A good example of liquidity risk is selling real estate. Real estate doesn’t have the adequate no. of buyers in comparison of sellers which results in the problem of liquidity.
- INFLATIONARY RISK:
The risk of a loss in your purchasing power because the value of your investments does not keep up with inflation. Inflation erodes the purchasing power of money over time – the same amount of money will buy fewer goods and services. Inflation risk is particularly relevant if you own cash or debt investments like bonds.
- CREDIT RISK:
This refers to the possibility that a particular bond issuer goes into financial problems and will not be able to make expected interest rate payments and/or principal repayment. Typically, the higher the credit risk, the higher the interest rate on the bond. Credit risk applies to debt instruments such as bonds.
- REINVESTMENT RISK:
Reinvestment risk is the risk of reinvesting the proceeds from the payment of principal and interest at a lower rate than the rate of original investment. Zero-coupon bonds are the only fixed-income instruments to have no reinvestment risk since they have no coupon payments.
- INTEREST RATE RISK:
it refers to the risk of losing money because of change in the interest rate. It applies to debt instruments such as bonds. There is a negative relationship between the price of bond & interest rates – if interest rate will increase the price of the bond will go down & vice versa. This risk can be reduced if you hold bonds till maturity.
- BUSINESS RISK:
the risk os going business in a particular industry or environment is called business risk. Example some commodities like fertilizers and oils are highly priced sensitive and the government policies os subsidies substantially affect the profitability of the companies engaged in manufacturing/marketing these products.
- REGULATION RISK:
Regulation risk refers to a risk that can impact a security due to the change in the laws and regulations of a country. Such changes in regulations can make significant changes in the framework of an industry, changes in cost-structure, etc.
- POLITICAL RISK:
Political risk is the risk in which an investment’s returns could suffer as a result of political changes or instability in a country. Instability affecting investment returns could arise from a change in government, legislative bodies, other foreign policymakers or military control. There are a variety of decisions governments make that can affect individual businesses, industries, and the overall economy. These include taxes, spending, regulation, currency valuation, trade tariffs, labor laws such as the minimum wage, and environmental regulations. Due to these changes the investment returns suffer.
- CURRENCY OR EXCHANGE RATE RISK:
Exchange rate risk is that form of risk which arises from the change in the price of one currency against another. For example, if you invest in debt or equity of some other country then you will face exchange rate risk. If some of your US investments earn 10% in one year in dollar terms but the same year dollar loses 2% in comparison to rupee – your actual return will fall down to 8%.
- COUNTRY RISK:
There are a variety of decisions governments make that can affect individual businesses, industries, and the overall economy. These include taxes, spending, regulation, currency valuation, trade tariffs, labor laws such as the minimum wage, and environmental regulations.