What kind of risk

The main types of market risk are equity risk, interest rate risk and currency risk. It is the risk of losing money because of a change in the interest rate.

Applies when you own foreign investments. The risk of being unable to sell your investment at a fair price and get your money out when you want to. To sell the investment, you may need to accept a lower price.

In some cases, such as exempt market investments, it may not be possible to sell the investment at all. The risk of loss because your money is concentrated in 1 investment or type of investment. When you diversify your investments, you spread the risk over different types of investments, industries and geographic locations. The risk that the government entity or company that issued the bond Bond A kind of loan you make to the government or a company.

They use the money to run their operations. In turn, you get back a set amount of interest once or twice a year. If you hold bonds until the maturity date, you will get all your money back as well. Credit risk Credit risk The risk of default that may arise from a borrower failing to make a required payment.

Your credit score is based on your borrowing history and financial situation, including your savings and debts. For example, long- term Term The period of time that a contract covers. Also, the period of time that an investment pays a set rate of interest. The risk of loss from reinvesting principal or income at a lower interest rate. Reinvestment risk Reinvestment risk The risk of loss from reinvesting principal or income at a lower interest rate. Reinvestment risk will not apply if you intend to spend the regular interest payments or the principal at maturity.

The risk of a loss in your purchasing power because the value of your investments does not keep up with inflation Inflation A rise in the cost of goods and services over a set period of time. This means a dollar can buy fewer goods over time.

In most cases, inflation is measured by the Consumer Price Index. Inflation erodes the purchasing power of money over time — the same amount of money will buy fewer goods and services. Inflation risk Inflation risk The risk of a loss in your purchasing power because the value of your investments does not keep up with inflation.

Shares offer some protection against inflation because most companies can increase the prices they charge to their customers. Share Share A piece of ownership in a company. Corporate bonds , on the other hand, tend to have the highest amount of default risk, but also higher interest rates. Bonds with a lower chance of default are considered investment grade , while bonds with higher chances are considered high yield or junk bonds.

Country risk refers to the risk that a country won't be able to honor its financial commitments. When a country defaults on its obligations, it can harm the performance of all other financial instruments in that country — as well as other countries it has relations with. Country risk applies to stocks, bonds, mutual funds, options, and futures that are issued within a particular country. This type of risk is most often seen in emerging markets or countries that have a severe deficit.

Foreign exchange risk or exchange rate risk applies to all financial instruments that are in a currency other than your domestic currency.

As an example, if you live in the U. Interest rate risk is the risk that an investment's value will change due to a change in the absolute level of interest rates, the spread between two rates, in the shape of the yield curve, or in any other interest rate relationship. This type of risk affects the value of bonds more directly than stocks and is a significant risk to all bondholders. As interest rates rise, bond prices in the secondary market fall—and vice versa.

This type of risk can stem from a change in government, legislative bodies, other foreign policy makers, or military control.

Counterparty risk is the likelihood or probability that one of those involved in a transaction might default on its contractual obligation. Counterparty risk can exist in credit, investment, and trading transactions, especially for those occurring in over-the-counter OTC markets. Financial investment products such as stocks, options, bonds, and derivatives carry counterparty risk. Typically, investors will require some premium for illiquid assets which compensates them for holding securities over time that cannot be easily liquidated.

The risk-return tradeoff is the balance between the desire for the lowest possible risk and the highest possible returns.

In general, low levels of risk are associated with low potential returns and high levels of risk are associated with high potential returns. This will be based on factors such as age, income, investment goals, liquidity needs, time horizon, and personality. The risk-return tradeoff only indicates that higher risk investments have the possibility of higher returns—but there are no guarantees. On the lower-risk side of the spectrum is the risk-free rate of return —the theoretical rate of return of an investment with zero risk.

It represents the interest you would expect from an absolutely risk-free investment over a specific period of time. The most basic — and effective — strategy for minimizing risk is diversification.

Diversification is based heavily on the concepts of correlation and risk. There are several ways to plan for and ensure adequate diversification including:.

Keep in mind that portfolio diversification is not a one-time task. The most effective way to manage investing risk is through regular risk assessment and diversification. Finding the right balance between risk and return helps investors and business managers achieve their financial goals through investments that they can be most comfortable with. Securities and Exchange Commission. Federal Reserve Bank of San Francisco. Treasury Bonds?

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Table of Contents Expand. What Is Risk? The Basics of Risk. Riskless Securities. It is unique to a company or a particular industry. For example strikes, lawsuits and such events that are specific to a company, and can to an extent be diversified away by other investments in your portfolio are unsystematic risk. Within these two types, there are certain specific types of risk, which every investor must know. Credit risk is just the risk that the person you have given credit to, i.

Government bonds have the lowest credit risk but it is not zero - think of Portugal, Ireland or Spain right now , while low rated corporate deposits junk bonds have high credit risk.

Remember, even a bank FD has some credit risk, as only a maximum of Rs. When a country cannot keep to its debt obligations and it defaults, all of its stocks, mutual funds, bonds and other financial investment instruments are affected, as are the countries it has financial relations with. If a country has a severe fiscal deficit, it is considered more likely to be risky than a country with a low fiscal deficit, ceteris paribus.

Emerging economies are considered to be more risky than developed nations. This is also higher in emerging economies.

It is the risk that a country's government will suddenly change its policies. For example, today with the continuing raging debate on FDI in retail, India's policies will not be looking very attractive to foreign investors, and stock prices are negatively affected.

This is the risk that you lock into a high yielding fixed deposit or corporate deposit at the highest available rate currently above 9. Currently as we are at an interest rate peak, it would be advisable to lock in for a longer tenor provided your financial goal time horizon permits to avoid facing reinvestment risk. A golden rule in debt investing is this: Interest Rates go up, prices of bonds go down. And vice versa.

So for example in our situation today, we appear to be at an interest rate peak. This means that since interest rates are going to go down from here, prices of bonds are going to go up. So if you were to invest in debt funds now, you would be buying at a low, and can sit back and watch as your investments start to give gains as interest rates fall.