Every day, we have to choose to move forward with the flow or step out of it. And the reality is, we cannot always know for sure what the decision we make will birth.
We can make predictions of what to expect based on the factors around and not around. But even with all the pointers, precedence, and guides, there exist a possibility that it can end up as something a little different or entirely unexpected. That possibility, notwithstanding how little, is the risk. And it is present in everything.
Risk is the possibility of the outcome of a decision taken or not taken to have a negative result or impact on people, the environment, systems, and assets. In the world of finance, Risk is the possibility of an investment’s outcome differing from the expected outcome or returns.
Almost all investment comes with a risk. And while this risk can be high or low, an investment with zero risk raises many red flags and questions. Risk can range from having low returns to having no returns at all to losing all your capital. The amount of risk is naturally determined by what is at stake. The very few investments considered risk-free, and are actually risk-free, are by the government or government-backed.
In investments, the interrelatedness of risk and returns is something every investor must understand in making an investment decision. Investments of high risk should have the potential for high returns. Staking your money or Asset at the risk of losing all of it should promise you more than a 10% one-time return.
Types of Risk
Systematic risks are the risk that is common to the entire economic market or the majority of it. The risks are woven into external factors that affect all or the majority of the market. The factors include a change in political climate, disaster, innovations, and other things that affect or contribute to the performance of the market. It is also known as market risk.
Unsystematic risks are the risks that are particular to a company or industry. Investors stand the risk of losing investments for factors that affect only that company or industry alone. It is also known as Specific risks and is influenced by several factors such as regulations, scarcity, emerging competitions, and change in management.
While the above are the two main categories of risks, other categories include:
Business risk: is the risk of a business being unable to generate enough revenue to cover the operational cost and make profit. This risk is influenced by demand, production costs, and competition.
Interest rate risk: is the risk of change in the value of the investment due to a change in interest rate.
Environmental and social risk: is the risk of the impact on the environment and social norms.
Country risk is the risk of a country being unable to fulfil its financial obligation and jeopardising the performance of all financial institutions in the country. This risk is country-specific.
Foreign exchange risk: is the risk of a change in the value of the investment due to a change in the exchange rate.
Political risk is the risk of an investment to yield low or zero returns due to political instability or change. This risk increases as the investment period prolong.
Counterparty risk is the risk of any stakeholders not honouring their commitment or pulling out of the contract halfway.
Avoiding risk would only mean not doing anything or not making any investment at all. And the presence of risk does not always mean it will turn out bad. It just means there is a possibility, high or low. What is of utmost importance is for investors to understand the degree and type of risk involved and allow it to influence their decision. Click here to read on Risk Management.