Risk exists in every action of our lives. It is simply the deviation of the actual happening from the expected result. The deviation may possibly be a positive or a negative outcome; however the term â¬Ërisk' is predominantly used in negative context. In financial world, risk is said to be existing when odds of actual return falling short of expected one are high.Â
We all undertake huge monetary investments in anticipation of returns and appreciation; however it is imperative to have knowledge of various risks involved which may limit the returns and appreciation of the investment. Though high risk investments tend to yield comparatively high returns one must bear the uncertainties.
A few of the risks that could arise are:
Â Credit Risk - One of the most commonly noticed forms of risk; it indicates the probability of loss an investor might have to incur if the borrower fails to make the required payments - default. In such case, the investor could end up losing interest as well as the principal amount.
Â Capital Risk - It refers to the possible loss an investor could face if his initial investment is lost.
Â Liquidity Risk - Certain investments involve trading of the asset at the right time to make profits. However, the inability of the holder of the asset in finding a buyer is referred to as liquidity risk.
Â Market Risk - Due to variations in main market factors viz., stock prices, foreign exchange rates, interest rates and commodity prices, if the value of your portfolio diminishes your investment is exposed to market risk.
Â Interest Rate Risk - An interest bearing instrument like bonds are usually subject to interest rate risk, which implies variation in the value of the instrument with changes in the interest rates. For ex: a fixed rate bond value tends to diminish with rising interest rates.Â
In order to manage and mitigate risks, one must identify, assess and prioritize risks and the probable loss. There are many risk management standards developed by institutions aiming at measuring and monitoring various risks.