What is investment? (Part-2)
Planting your Money
Happy day, amazing people!!!
Let’s continue with part-2 ….
Risks in investments
Investments have two types of risk, systematic risk and unsystematic risk.
| Systematic Risk | Unsystematic Risk |
| Systematic risk are ore external in nature. They are beyond the control of corporations and investors. The main reason for their occurrence is due to changes in social, economic and political systems. | Whereas on the other hand unsystematic risk are more unique firm/industry which can be controlled by them . |
| Diversification of risk is possible in this case. | Investors can also diversify their risk by making changes in the portfolio. |
A} Systematic risk
Inflation risk: For instances, Ethan buys a debt instrument for $100 which will pay him a fixed income of 5% per annum. By the end of the year, it would amount to $105.
If the inflation rate is 5% or less, then he need not worry about purchasing power erosion. But if it is more than 5% Ethan’s purchasing power will get eroded.
Interest rate risk: If the interest rate of a bond investment is 7% but thereafter, market offers the same type of bond for 8% then it is called interest rate risk. This will create a difficulty for the inventors to sell the bond because it is a low yielding bond and also decreases the value of the bond.
Market risk: When a new, well performing company goes public and sells it share in the stock market, the demand for it will increase. Since the supply will be low, prices go up.
And on the other hand, if there are more companies of same type in the stock market, then the supply will increase leading to decline in price.
These phenomena are called market risk, which investors must be careful of.
Exchange rate risk: Let say William, who is an American investor in a foreign market, the London Stock Exchange (LSE). If the exchange rate is 1:1 (which means $1=£1) there will be no problem of loss for William when he is exchanging his foreign currency into national currency.
But if the exchange rate fluctuates to 1:0.75 (which means $1=£0.75) then he will have to incur a loss of £0.25. This is known as exchange rate risk.
B} Unsystematic risk
Business risk: Business risk can be internal and external to the company.
Internal risk – Problem in sourcing the raw material, low production, labour problem, management inefficiency, failing to obtain a patent
External – Changes in government policies, different strategies by competitors, unforeseen market condition
Financial risk: Financial risk is based on the capital structure of the company. Every company must maintain its debt-equity ratio in an optimal level. If not, it can affect the cash flow and earnings.
We hope you guys have understood about risks in investment and their types.
Ok then before signing off
Love what you do, do what you love…. Bye
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