When you invest in the financial market, you are exposed to different types of risk. The risk is an inherent aspect of every form of investment aspect of every kind of investment. The risk is usually used to imply downside risk. It is the uncertainty of a return and the potential for financial loss.
The various risks which affect your investment returns in the financial market are the market risk, inflation risk, credit risk, interest rate risk, investment risk, liquidity risk, Social/Political/Legislative risk, exchange rate risk, reinvestment risk, concentration risk, foreign investment risk.
Let us go through them one by one in brief.
It is the risk of investments declining in value due to economic developments or other events that affect the entire market. The prices or yields of all securities in particular market risk or fall to large outside influences. This change in rate is due to market risk.
It is the risk of a loss of your purchasing power because the value of your investments does not keep up with inflation. This is sometimes referred to as ‘loss of purchasing power.’ Whenever the rate of inflation exceeds the earnings on your investments, you will run the risk that you will be able o buy less and not more.
In short, how stable is the company or entity to which you lend your money when you invest? How confident are you that will be able to pay the interest you are promised or repay your principal when the investment matures? It is the risk that the government or the company that issued the bond will run into financial difficulties and won’t be able to pay the interest or repay the principal at maturity.
Interest rate risk:
Interest rate movements in the Indian debt markets can change time to time and lead to the possibility of significant price movements up or down in debt and money market securities.
It is the probability or chance of occurrence of losses relative to the expected return on any particular investment.
This occurs due to the inability to convert security or asset to cash easily without a loss of capital and income.
It is due to changes in legislation, changes in government policies. Instability in the country, change in foreign policies. Social changes are causing a loss in value. Any government policy which results in adverse consequences is known as legislative risk.
Exchange rate/currency risk:
Fluctuations in foreign currency in which an investment is valued compared to home currency may add risk to the value of a security.
Investors such as bondholders who would like to re-invest the proceeds after redemption. In case of declining, interest rate situation will lead to lead to a decline in cash flow from an investment when its principal and interest payments are reinvested at lower rates.
This risk is associated because all our money is concentrated in one investment. When you diversify your investments, you spread the risk over different types of investments, industries and geographic locations.
Foreign investment risk:
There is a risk involved when investing in foreign companies. When you buy investments of a foreign company, you may face risk, for example, the risk of nationalization.