Personal Development, Business, Finance, and Investing for Everyone
An investment in knowledge always pays the best interest.
Investing is about weighing risk against reward. It is important to understand all of the many risks that can affect your investment funds. Each risk affects another; they are all connected.
What is Risk?
Risk is defined in financial terms as the chance that an outcome or investment's actual gains will differ from an expected outcome or return. Risk includes the possibility of losing some or all of the original investment.
Standard deviation is a common metric to measure the total amount of risk one has to face. It provides a measure of the volatility of asset prices in comparison to historical averages in a given time frame.
What are the different types of risk?
Investors have to face two main types of risk when investing.
Undiversifiable or Systematic/Market Risk
Systematic risk occurs due to macroeconomic factors. It is beyond the control of a specific company or individual and, hence, can't be diversified. All investments and securities suffer from this type of risk. One can't eliminate such a risk by holding more shares.
The risk includes all the unforeseen events that happen in everyday life, thus making it beyond the control of the investors. Systematic risk impacts the entire industry rather than a single company or security. Common causes include inflation rates, exchange rates, political instability, war, and interest rates.
Unsystematic Risk or Diversifiable Risk
Common sources of unsystematic risk are business risk and financial risk. Thus, the aim is to invest in various assets so they will not all be affected the same way by market events. This varied risk can be avoided by various companies or industries by opting for a suitably diversified portfolio.
What are the types of Systematic Risk?
Interest Rate Risk
Such a risk is the result of a change in the market interest rate. It mainly impacts fixed-income securities, as bond prices are inversely related to the interest rate.
It is the result of the general tendency of investors to move with the market. So, security prices tend to move collectively. For instance, in a falling market, the stock price of even the best-performing company drops. Usually, market risk accounts for about two-thirds of total systematic risk.
Purchasing Power Risk or Inflation Risk
Risk occurs due to the erosion in the purchasing power of money. Inflation is the rise in the general price level, meaning the same amount of money buys fewer goods and services. So, if the income of the investor falls to keep pace with the rising inflation, then in the real term, he is earning less than before. Similar to interest rate risk, purchasing power risk also mainly affects fixed-income securities because the income from such securities is fixed.
Exchange Rate Risk
The risk stems from the uncertainty of the changes in the value of the currencies. So, it affects only the companies doing foreign exchange transactions, like export and import companies.
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ABOUT THE BLOGGER
Hi, I'm Ralph Gregore Masalihit!
An RFP Graduate (Registered Financial Planner Institute - Philippines).
A Personal Finance Advocate. An I.T. by Profession. An Investor. Business Minded. An Introvert. A Photography Enthusiast. A Travel and Personal Finance Blogger (Lakbay Diwa and Kuripot Pinoy).
Currently, I'm working my way toward time and financial freedom.