Risk
The deviation between actual and expected returns is the risk in his investment. If the return from an investment remains unchanged over time, there would be no risk. But, there is no investment of that kind in the real world. Deviations from expected outcomes can be positive or negative, both are considered to be risky. All investment are subject to risk, but the type and extent of risk are different.
Types Of Risk
1. Market Risk - Systematic and Unsystematic
Total risk consist of two parts. The part of risk that affects the entire system is known as systematic risk, and the part that can be diversified away is known as unsystematic risk. Systematic risk is caused due to factors that many affect the economy/ markets as a whole, such as changes in government policy, external factors. Inflation risk, exchange rate risk, interest rate risk are systematic risk. Unsystematic risk is the risk specific to individual securities or a small case of investments.
Credit risk, business risk are unsystematic risks.
2. Inflation Risk
Inflation risk is also known as purchasing power risk. It is a risk that arises from the decline in value of security's cash flows due to the falling purchasing power of money. Inflation risk represents the risk that the money received on an investment may be worth less when adjusted for inflation.
3. Interest rate risk
It refers to the risk that bond prices will fall in response to rising interest rates. Interest rate is inversely proportional to bond price, share price.
4. Liquidity risk
It implies that the investor may not be able to sell his investment when desired, or it has to be sold below its intrinsic value, or there are high costs to carrying out transactions.
5. Exchange rate risk
It is incurred due to changes in the exchange rate of domestic currency relative to a foreign currency. When a domestic investor invests in foreign assets, or a foreign investor invests in domestic assets, the investment is subject to exchange rate risk.
No comments:
Post a Comment