Risk and Different Risk Types Associated with Investments

          I have seen many people talking about risk when they are making investments yet majority of them aren’t aware of the different types of risk associated with investment and to manage or minimize the effect of risk on their portfolio. They just know that low risk, moderate risk and high risk and have half knowledge about it which we all know that it is dangerous. So today in this article let us try to understand risk meaning, uncertainty meaning, risk management meaning and different types of risk.

Risk

          Risk can be defined as an uncertain event in the future which has cause and effect and threatens or limits an individual or organization to achieve its goals and mission. Risk can be unexpected and unpredictable event that causes loss in one or the other way. Now the question is what do you mean by Uncertainty?

Uncertainty

          Uncertainty is the state where current state of knowledge about the event is unknown and its consequences are also unknown i.e. in simple words an individual has no control or awareness about the forth coming event and outcome of the event.

Risk Management

          Risk Management is the process identification evaluation and prioritization of the risk by monitoring and controlling the probability of risk in order to minimize the risk to the maximum possible extent. Risk Management is a process where you identify the risks and setting up a strategy to overcome it.

Risk Types

          Different types of risk that are associated with investment are as follows,

§  Default Risk

Default Risk refers to the type of risk where an individual or company falling to make payments to their debt obligations. In other words default risk is the risk where exposure of loss arises due to the non-payment by the borrower when individual or company has to pay its debt.

For Instance, A company took the raw materials on credit for a period of 60 days. After 60 days the supplier produces the bill for payment but the company falls to make the payment. This risk is referred to as default risk.

§  Business Risk

Business Risk refers to a possibility of company’s exposure which is making inadequate profits due to the uncertainty in the future. Inadequate profits mean company is making fewer profits than its anticipated profits. In simple words business risk refers to any future uncertainty that prevents the business from achieving its business goals.

§  Financial Risk

Financial Risk refers to the threat which results in financial loss to investors, shareholders and other financial stakeholders. It is generally related with financial losses. Various forms of financial risk are credit risk, currency risk, investment risk, liquidity risk, cash flow risk and many more.

§  Purchasing Power Risk

It is also known as Inflation risk. Purchasing Power risk refers that risk which arises due to the inflation which results in decrease in the cash flows in the future. I simple word the cash flows of the investment in future aren’t worthy enough because of changes in purchasing power due to the inflation. Inflation decreases the purchasing power of the Consumer Price Index (CPI).

§  Interest Rate Risk

Interest Rate Risk refers t to the risk that arises due to the fluctuation in the interest rate. The risk varies with change in the interest rate risk. Interest rate risk is usually associated with bonds or any fixed income assets.

§  Systematic Risk

Systematic Risk is also known as undiversified risk or Market Risk. Systematic risk arises due to the performance of the entire market. It is unpredictable and unavoidable completely. Systematic risk or market risk is a result of fluctuation in the market prices. It cannot be minimized by the diversification of the portfolio but only through hedging with proper asset allocation strategy. Systematic Risk is a result of the macroeconomic factors affecting a firm or business entity.

§  Unsystematic Risk

Unsystematic Risk is also known as “Specific Risk”, “Non-systematic Risk”, “Diversifiable Risk”, and “Residual Risk”. Unsystematic Risk is risk that is related to a specific industry or a company and can be minimized by the investor by diversifying his portfolio. Unsystematic Risk can be measured and managed proper risk management tools.