What are different types of Risks?
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Answer Posted / zahid rahman
* Systematic Risk - Systematic risk influences a large
number of assets. A significant political event, for
example, could affect several of the assets in your
portfolio. It is virtually impossible to protect yourself
against this type of risk.
* Unsystematic Risk - Unsystematic risk is sometimes
referred to as "specific risk". This kind of risk affects a
very small number of assets. An example is news that affects
a specific stock such as a sudden strike by employees.
Diversification is the only way to protect yourself from
unsystematic risk. (We will discuss diversification later in
this tutorial).
Now that we've determined the fundamental types of
risk, let's look at more specific types of risk,
particularly when we talk about stocks and bonds.
* Credit or Default Risk - Credit risk is the risk that
a company or individual will be unable to pay the
contractual interest or principal on its debt obligations.
This type of risk is of particular concern to investors who
hold bonds in their portfolios. Government bonds, especially
those issued by the federal government, have the least
amount of default risk and the lowest returns, while
corporate bonds tend to have the highest amount of default
risk but also higher interest rates. Bonds with a lower
chance of default are considered to be investment grade,
while bonds with higher chances are considered to be junk
bonds. Bond rating services, such as Moody's, allows
investors to determine which bonds are investment-grade, and
which bonds are junk. (To read more, see Junk Bonds:
Everything You Need To Know, What Is A Corporate Credit
Rating and Corporate Bonds: An Introduction To Credit Risk.)
* Country Risk - Country risk refers to the risk that a
country won't be able to honor its financial commitments.
When a country defaults on its obligations, this can harm
the performance of all other financial instruments in that
country as well as other countries it has relations with.
Country risk applies to stocks, bonds, mutual funds, options
and futures that are issued within a particular country.
This type of risk is most often seen in emerging markets or
countries that have a severe deficit. (For related reading,
see What Is An Emerging Market Economy?)
* Foreign-Exchange Risk - When investing in foreign
countries you must consider the fact that currency exchange
rates can change the price of the asset as well.
Foreign-exchange risk applies to all financial instruments
that are in a currency other than your domestic currency. As
an example, if you are a resident of America and invest in
some Canadian stock in Canadian dollars, even if the share
value appreciates, you may lose money if the Canadian dollar
depreciates in relation to the American dollar.
Interest Rate Risk - Interest rate risk is the risk
that an investment's value will change as a result of a
change in interest rates. This risk affects the value of
bonds more directly than stocks. (To learn more, read How
Interest Rates Affect The Stock Market.)
* Political Risk - Political risk represents the
financial risk that a country's government will suddenly
change its policies. This is a major reason why developing
countries lack foreign investment.
* Market Risk - This is the most familiar of all risks.
Also referred to as volatility, market risk is the the
day-to-day fluctuations in a stock's price. Market risk
applies mainly to stocks and options. As a whole, stocks
tend to perform well during a bull market and poorly during
a bear market - volatility is not so much a cause but an
effect of certain market forces. Volatility is a measure of
risk because it refers to the behavior, or "temperament", of
your investment rather than the reason for this behavior.
Because market movement is the reason why people can make
money from stocks, volatility is essential for returns, and
the more unstable the investment the more chance there is
that it will experience a dramatic change in either direction.
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