There are various types of risks associated with the transactions of financial instruments. Each risks of financial instruments has its distinctive characteristics. Before making any investment in financial instruments, investors must evaluate the risks and rewards in the investments. However, the main risks of financial instruments are described shortly, in below section.
The main risks of financial instruments are set out in notes. They include:
(A) Market risk
(B) Credit risk, and
(C) Liquidity risk.
(A) Market risks: Market risks are comprised of :
(1) currency risk – the risk that the value of a financial instrument will fluctuate because of changes in foreign exchange rates;
(2) interest rate risk – the risk that the value of a financial instrument will fluctuate because of changes in market interest rates;
(3) other price risk – the risk that the value of a financial instrument will fluctuate as a result of changes in market prices.
Market risks of financial instruments are embodied with the potential for both loss and gain.
(B) Credit risk is the risk that one party to a financial instrument will fail to discharge an obligation and cause the other party to incur a financial loss.
(c) Liquidity risk is the risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities. This is also known as funding risk.
Since above risks of financial instruments are prevailing, investors have to follow precautions before investments.