12-04-2012, 03:58 PM
Macro Risk Levels
Micro Risk Levels
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While the above risk types are the macro scale levels of risk, there are also some more important micro (small-scale) types of risks that are important when talking about the valuation of a stock or bond. These include:
• Liquidity Risk –
The uncertainty introduced by the secondary market for a company to meet its future short-term financial obligations. When an investor purchases a security, they expect that at some future period they will be able to sell this security at a profit and redeem this value as cash for consumption – this is the liquidity of an investment, its ability to be redeemable for cash at a future date. Generally, as we move up the asset allocation table – the liquidity risk of an investment increases.
• Financial Risk –
Financial risk is the risk borne by equity holders (refer Shares section) due to a firms use of debt. If the company raises capital by borrowing money, it must pay back this money at some future date plus the financing charges (interest etc charged for borrowing the money). This increases the degree of uncertainty about the company because it must have enough income to pay back this amount at some time in the future.
• Exchange Rate Risk –
The uncertainty of returns for investors that acquire foreign investments and wish to convert them back to their home currency. This is particularly important for investors that have a large amount of over-seas investment and wish to sell and convert their profit to their home currency. If exchange rate risk is high – even though a substantial profit may have been made overseas, the value of the home currency may be less than the overseas currency and may erode a significant amount of the investments earnings. That is, the more volatile an exchange rate between the home and investment currency, the greater the risk of differing currency value eroding the investments value.
• Country Risk –
• This is also termed political risk, because it is the risk of investing funds in another country whereby a major change in the political or economic environment could occur. This could devalue your investment and reduce its overall return. This type of risk is usually restricted to emerging or developing countries that do not have stable economic or political arenas.
• Market Risk –
The price fluctuations or volatility increases and decreases in the day-to-day market. This type of risk mainly applies to both stocks and options and tends to perform well in a bull (increasing) market and poorly in a bear (decreasing) market (see bull vs bear). Generally with stock market risks, the more volatility within the market, the more probability there is that your investment will increase or decrease.