Investment Risk

Risk is defined as the possibility that what is actually earned as return could be different from what is expected to be earned. 

A. Market Risk
i. Systematic risk refers to those risks that are applicable to the entire financial market or a wide range of investments. these risks are also known as un-diversifiable risk, because they cannot be eliminated through diversification.

• It is caused due to factors that may affect the economy/market as a whole, such as changes in government policy, external factors, wars or natural calamities.

ii. Unsystematic Risk is the risk specific to individual securities or a small class of investment. 
For example: Credit Risk, Business risk & Unsystematic risk.


B. Inflation Risk:

• It represent the risk that the money received on an investment may be worth less when adjusted for inflation.
•  It is also known as purchasing power risk.
• It is a risk that arises from the decline in the value of securities cash flows due to the falling purchasing power of money.

C. Interest Rate Risk:

• It is the risk that bond prices will fall in response to rising interest rates, and rise in response to declining interest rates.
• Bond prices and interest rates have an inverse relationship.
• Bond investment are subject to volatility due to interest rate fluctuations. This risk also extends to debt funds, which primarily hold debt assets.

D. Purchasing power risk:

• The best way to fight against this type of risk is through appreciable investments such as stocks or convertible bonds, which have a growth component that stays ahead of inflation over the long term.

E. Liquidity Risk:

• It refers to the ease with which an investment can be bought or sold in the market.
• It implies that the investor may not be able to sell his investment when desired, or it has to be sold below its intrinsic value, or there are high costs to carrying out transactions.

F. Re-investment Risk:

• It arises from the probability that income flows received from an investment may not be able to earn the same interest as the original interest rates.
• The risk is that intermediate cash flows may be reinvested at a lower return as compared to the original investment.

G. Exchange Risk:

• It is incurred due to changes in the exchange rate of domestic currency relative to a foreign currency.
• When a domestic investor invests in foreign assets, or a foreign investor invests in domestic assets, the investment is subject to exchange rate risk.

H. Regulatory Risk:

• It is the risk of a change in regulations and law that might affect an industry or a business.

I. Investment Manager (Alpha) Risk:

• The return of portfolio is dependent on the fund managers skill to take correct decisions and in turn translate the portfolio return in capital gain over the period.
• Alpha is a measure of excess return over a benchmark and is positive when portfolio outperform a benchmark and negative when portfolio underperforms the benchmarks. 
• Since the portfolio can underperforms the benchmark, investor is exposed to risk and is known as investment risk  or alpha risk.

J. Business Risk:

• It is risk inherent in the operations of a company. It is also known as operating risk, because this risk is caused by factors that affect the operations of the company.
• Common sources of business risk include cost of raw material, employee costs, introduction and position of competing products, marketing and distribution costs.