Risk

As I am a risk adverse person, I will not cover on returns just yet. Risk is something that comes hand in hand with returns, unless it is a risk free asset. There are several ways of looking at risks. The various sources of risks will be examined, leading to an understanding that different types of investments are exposed to different types of risks.

Risk can be further classified into systematic risks and unsystematic risks depending on the source of the risk. Systematic risk represents risk that is common to all assets. It cannot be diversified away. On the other hand, unsystematic risk represents risk that is unique to an asset and can be diversified away.

Examples of systematic risk are interest rate risk, inflation risk, market risk, reinvestment risk and exchange rate risk. I will discuss more on reinvestment risk as the rest of them are more or less self explanatory. An investor face reinvestment risk when he may not able to reinvest the dividends, coupon receipts or other cash flows from his existing investment in order to achieve his targeted rate of return.

An example will be if an investor may wish a return of 8% over a period of 5 years. He buys a 5 year bond with a yield of 8%. However, he may not achieve a realized yield of 8% after 5 years because he may not be able to reinvest the coupon payments at 8%.

Unsystematic risk will be country risks, liquidity risk (ability to convert into cash as quickly as possible), business risk, credit risk (external indebtedness of the company to debt holders other than equity holders), industry risk and financial risk.( arises when a company incurs debt)

Be sure to asses the risk of any investment. Investment opportunity will always be there waiting for you. Conversely, losses also will be there for you if you do not asses risk and make due diligence