Investment Risks Explained | eBook | AudioBook

The Following is an Excerpt from this Book

It is nothing but death and taxes, can be claimed to be undeniable in this universe as once remarked by Benjamin Franklin. There is a third option widely prevalent in the modern world viz., investment risk. One cannot deny an investment without risk. Mutual funds shares, stocks, and exchange-driven funds will drop in value, maybe even their full value if the market dynamics are low. And also safe, insured assets, including deposit certificates (C.D.s), bear their little kind of risk: a threatening risk of inflation. Since investment risk is a reality, it rests on people to consider those risks such that they can judge what to do with the existing financial assets with trust and conviction. To consider risk, one may find mainly two broad classifications. Initially, there is a universal business risk. Business risks, or in other words, non-systemic risks, are the risk elements associated with focusing on investment in a specific company, industry, or product. Market risk is the second common category to look upon. The overall economy or securities market is influenced by market risk. It refers to the risk that an overall dwindling of the market will throw the value of all investments made or committed, irrespective of their individual capacity or inadequacy.
Usually, people may encounter nine types of investment risks which are as follows:

Market risks
Market risk refers to an opportunity for an investor to experience losses because of factors affecting the overall discharge of the monetary markets wherein stakeholders are involved.
Country risk: The risk that happens in a country where an investment is being made might affect global market intensity. It may happen, when a nation is revamping its statutes, changing its policies, or experiencing public upheaval or war.
Socio-political risk: It entails risks associated with social and political events that might impact the capital sector, such as a pandemic, war, elections, or a terrorist attack. These incidents may influence investors’ expectations and perspectives, if real or predicted, resulting in system-level swings in share prices.
Interest rate risk: It may be the risk that contributes to the fluctuation of security’s value caused by interest rate changes. Bonds are directly prone to an impact due to subtle variations in interest rates. The price of a previously issued bond tends to fall with the increase in interest rates. On the contrary, bond prices rise with a fall in interest rates. The justification behind it is that a bond is a pledge of a future payment flow. An investor will offer less for a bond that ends up paying out at a rate lower than the actual market rates and vice versa.
Currency risk: The return on investment can increase or decrease due to any shift in the exchange rate between two related currencies. If people own stock in a multinational enterprise or a big corporate with substantial international revenues, they’re likely to be exposed to currency risk.
Legal remedies risk: The is a possibility that if people have an investment problem, they will not have ample legal means to fix it. People often have to rely on the legal measures that are available in that country to address issues when they invest in a global market. Such steps that vary from the ones that people may get used to in the home country.
Inflation risk: The prospect of common stuff increases in the costs of commodities and services will weaken the purchasing power of money resources and will contribute to negativity on the valuation of investments. Interest-rate risks and inflation are strongly connected as interest rates usually increase with the spread of inflation. However, inflation tends to be cyclical, as well. Fresh bonds are likely to offer lower interest rates during spans of low inflation, which may encourage investors to go for higher-risk bonds providing enhanced rates.
Liquidity risk: It is the risk that one will not be able to instantly buy or sell investments for a market value that detects the asset ‘s true relative value, or that he cannot dispose of the investment whatsoever due to the absence of buyers in the market.
Business risks
The possibility of a business enterprise, making small profits because of uncertainties is regarded as business risks. To illustrate, changes in government policy, changing consumer preferences, strikes, changes in tastes, obsolescence, increased competition, etc. are types of business risks.
Credit risk: A bond issuer at risk when he fails to make interest payments or repay the principal when as and when the bond matures.
Management risk: This kind of risk is inherited in the regular operations of a business. For instance, the risk that the crucial product line for the industry will be shelved, that production costs will keep rising, or that a major executive will depart, adversely affecting the company’s ability or its value to repay the debts. Those risks vary by industry and group of companies.
One can handle the investment risk and take measures to reduce the exposure, while investment risk cannot be eliminated entirely. However, people must first understand the risk varieties they are facing before doing this because several investment products are prone to different types of risks. Diversification of investments is one of the effective ways to address the risk. Diversifying the ways can reduce both market and business risks to some level, not only at the stage of the sector or product but also in the concerning area (internal and overseas) and duration of holding periods (both short and long-term). Through diversifying the assets over many countries or territories, people can spread their proposed international risk.
Besides, if people rehearse well, they can manage risk well in advance. One might gain the strengths that can impact his investment. The need of the hour is to acquire knowledge about innovations and changes in the global economy. Also, people have to learn about the future of any specific organization provided they are contemplating investing in a particular area. One must make sure to appreciate the local environment as well as the political scenario if he is considering investing in a prospective nation.