Every investment that you make is basically classified into risk and return. They are two sides of the same coin and hence are not disjointed. To know how to handle this let’s look at the following risk associated with every investment. There are 7 types of risk which are listed below
- Unsystematic Risk
- Credit Risk
- Country Risk
- Foreign Exchange Risk
- Interest Rate Risk
- Political Risk
Risk 1: Systematic risk is the inherent risk in the market or a segment of business associated with your investments that can affect a large portion of assets. This risk cannot be diversified and you can do little about it as it affects not just stock but the entire industry.
Illustration: Let’s assume you bought 100 shares of Ashok Leyland and 50 shares of Maruti Suzuki stock. If the automobile industry goes through a rough phase then you can’t do anything about it. Also, the company will not be able to do much if the product demand has slow down.
Risk 2: Unsystematic risk, on the other hand, is a diversifiable risk specific to the few assets. You can control the risk. This can be pertaining to a single company, promoters, management change or regulatory impact to the way the company does business. It is possible to mitigate this risk by proper diversification
Risk 3: Credit risk is the ability of the company to services (interest payment) its debt on time without delay and also be able to pay off (redeem) the debt in full when it is due for maturity. This risk is associated with bonds, fixed deposits, and debentures. While rating agency provide the credit rating that serves as guidance, it is prudent for investors to check the financial status before investing in such bonds
Risk 4: Country risk is when the country is not able to service the debt it has taken from other countries or global organizations. Countries like Zimbabwe, Venezuela have faced huge risk due to the unstable economic situation
Risk 5: Foreign exchange risk is also referred to as currency risk When companies have business transaction across the border with other countries then they are exposed to such currency risk. Similarly, if there are borrowing denominated in foreign currency then to they are exposed to currency depreciation. While exporters of good can an inverse relationship and can benefit out of foreign currency depreciation
Risk 6: Interest rate risk is when the price of the underlying securities drops when the interest rate in the market goes up. Bonds prices and yield have an inverse relationship and hence if yields go up then bond prices fall and hence can cause a loss in the portfolio. If the duration of the bond is high then fall in the price of the bond will be higher. So If we expect interest to go up then choose short-term bonds and if interest were to go down chose long maturity
Risk 7: political risk is when the price of the underlying securities is affected due to change in government. Legislature or state of emergency or a military coup can affect the bond or equity prices. A sudden bankruptcy can alter the risk of the country and its currency value.