Question

Use investments to explain risk. Outline, with a short description, the 4 types of investment risks.

Answer 1

Investment risk describes the likelihood of potential losses when you're making an investment. Risk is the general likelihood of losing the authentic investment, and investments are exposed to different types of risks throughout the lifecycle of the investment. Since some assets react positively to changes in these risks while others react negatively, such risks can be diversified away. In other words, investors who take the right steps to diversify can efficiently get rid of half of the sources of risk in their portfolio.

Followings are the primary 4 of the many investment risks -

1. Inflation Risk: The prices of bond-like investments, and hard assets like commodities and gold, are primarily impacted by changes in inflation expectations.The need to stay ahead of inflation over time is a powerful reason why investors turn to growth investments like stocks, even though this means accepting frequent price fluctuations and the risk of permanent losses.
2. Interest rate risk: Interest rate risk is the possibility of a drop in the value of an asset resulting from unexpected fluctuations in interest rates. Interest rate risk is majorly associated with fixed-income assets & less with equity investments. Price volatility is limited and the principal is guaranteed upon maturity. However, their interest rates are subject to be volatile over time and that can greatly affect your rate of return on investment.
3. Liquidity risk: Liquidity risk is the risk that a company or bank may be unable to meet short term financial demands. Liquidity risk usually arises when a business or individual with immediate cash needs, holds a valuable asset that it can not trade or sell at market value due to a lack of buyers, or may be due to an inefficient market where it is really difficult to bring market participants such as buyers & sellers together.
4. Default risk: The risk of non paymen refers to both interest & principal. This risk is very high in case of unsecured loans because of no collateral attached.