Question

Write a 300-400 word paper responding to the following:

Types of Risk: Investment Risk, Diversification, Inflation, Longevity Risk , Political Risk, Identity Risk

1. Define and describe four different types of risks that apply to your personal financial situation.
2. What actions might you take to avoid or mitigate these risks?

Please Answer in First person Writing.

Answer 1

a. Risk is defined in financial terms as the chance that an outcome or investment's actual gains will differ from an expected outcome or return. Risk includes the possibility of losing some or all of an original investment. Overall, it is possible and prudent to manage investing risks by understanding the basics of risk and how it is measured. Learning the risks that can apply to different scenarios and some of the ways to manage them holistically will help all types of investors and business managers to avoid unnecessary and costly losses.

1. Risk takes on many forms but is broadly categorized as the chance an outcome or investment's actual gain will differ from the expected outcome or return.

2. Risk includes the possibility of losing some or all of an investment.

3. There are several types of risk and several ways to quantify risk for analytical assessments.

4. Risk can be reduced using diversification and hedging strategies

Types of Financial Risk

Every saving and investment action involves different risks and returns. In general, financial theory classifies investment risks affecting asset values into two categories: systematic risk and unsystematic risk. Broadly speaking, investors are exposed to both systematic and unsystematic risks.

                                         Systematic risks, also known as market risks, are risks that can affect an entire economic market overall or a large percentage of the total market. Market risk is the risk of losing investments due to factors, such as political risk and macroeconomic risk, that affect the performance of the overall market. Market risk cannot be easily mitigated through portfolio diversification. Other common types of systematic risk can include interest rate risk, inflation risk, currency risk, liquidity risk, country risk, and sociopolitical risk.

                                       Unsystematic risk, also known as specific risk or idiosyncratic risk, is a category of risk that only affects an industry or a particular company. Unsystematic risk is the risk of losing an investment due to company or industry-specific hazard. Examples include a change in management, a product recall, a regulatory change that could drive down company sales, and a new competitor in the marketplace with the potential to take away market share from a company. Investors often use diversification to manage unsystematic risk by investing in a variety of assets.

Business Risk

Business risk refers to the basic viability of a business—the question of whether a company will be able to make sufficient sales and generate sufficient revenues to cover its operational expenses and turn a profit. While financial risk is concerned with the costs of financing, business risk is concerned with all the other expenses a business must cover to remain operational and functioning. These expenses include salaries, production costs, facility rent, office, and administrative expenses. The level of a company's business risk is influenced by factors such as the cost of goods, profit margins, competition, and the overall level of demand for the products or services that it sells.

Credit or Default Risk

Credit risk is the risk that a borrower will be unable to pay the contractual interest or principal on its debt obligations. This type of risk is particularly concerning to investors who hold bonds in their portfolios. Government bonds, especially those issued by the federal government, have the least amount of default risk and, as such, the lowest returns.

Country Risk

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

When investing in foreign countries, it’s important to consider the fact that currency exchange rates can change the price of the asset as well. 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.S. and invest in a Canadian stock in Canadian dollars, even if the share value appreciates, you may lose money if the Canadian dollar depreciates in relation to the U.S. dollar.

Interest Rate Risk

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.

Political Risk

Political risk is the risk an investment’s returns could suffer because of political instability or changes in a country. This type of risk can stem from a change in government, legislative bodies, other foreign policy makers, or military control. Also known as geopolitical risk, the risk becomes more of a factor as an investment’s time horizon gets longer.

Counterparty Risk

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.

Liquidity Risk

Liquidity risk is associated with an investor’s ability to transact their investment for cash. Typically, investors will require some premium for illiquid assets which compensates them for holding securities over time that cannot be easily liquidated.

b. Effective Risk Mitigation Strategies

Avoidance

If a risk presents an unwanted negative consequence, you may be able to completely avoid those consequences. By stepping away from the business activities involved or designing out the causes of the risk you can successfully avoid the occurrence of the undesired events.

One way to avoid risk is to exit the business, cancel the project, close the factory, etc. This has other consequences, yet it is an option.

Acceptance

Every product produced has a finite chance of failing in the hands of your customer. When that risk is at an acceptable level, sufficiently low estimated field failure rate, then ship the product. Accept the risk.

When the decision to accept the risk is in part based on an estimate or prediction, there is the risk the information incorrectly forecasts the future. Therefore, for high consequence related field failures, closely monitoring field performance or establishing early warning systems may be prudent.

Reduction or control

If it is not possible to reduce the occurrence or severity, then implementing controls is an option. Controls that either detect causes of unwanted events prior to the consequence occurring during use of the product, or the detection of root causes of unwanted failures that the team can then avoid.

Controls may focus on management or decision-making processes. Improving the ability to find design flaws or to improve the accuracy of field failure rate prediction both improve the ability to make the appropriate decisions concerning risk.

Another method to reduce or control risk is to diversify. Thinking through the mix of products, technologies, markets, operations, and supply chains permit the team the ability to limit the high-risk opportunities to a manageable or acceptable level.

Transference

This strategy is to shift the burden of the risk consequence to another party. This may include giving up some control, yet when something goes wrong your organization is not responsible.This approach may not work to protect your brand image if the product is associated with your organization. Even if the power supply vendor pays for all damages due to failures in their unit, the customer only knows that your product has failed and caused damage. Use this approach with caution.