Question

DO NOT COPY SOMEONE ELSE'S ANSWER..... What kinds of risks are included in investment risk? Go online to survey current or recent financial news. Find and presents a specific example of the impact of each type of investment risks. In each case, how did the type of risks affect investment performance?

Answer 1

Types of investment risks:

• Market risk:

This is the risk that an investment would face fluctuations & decline in value because of economic developments & other events that can influence the entire market. This is referred to as systematic risk. For example, if you have a forward contract to buy oil for a price of $50/barrel, there is “Market Risk” that the price will move below that price to say $40/barrel at the time point when the contract matures. And, that price makes the forward contract have negative value. The market risk can have an impact on the overall performance of the financial markets.

• Specific risk: also known as unsystematic risk. This is a risk related to a specific company or industry. The main reason for these kinds of risks is bad management, failure of a product or a service, sudden strike by the company employees, new government regulations etc. For example, management failing to take a patent to protect a new product would be an internal risk which can result in the loss of competitive advantage.
• Volatility risk: Volatility risk is the risk of a change of price of a portfolio as a result of changes in the volatility of a risk factor. It usually applies to portfolios of derivatives instruments, where the volatility of it’s under lying is a major influence of prices. When volatility increases, risk increase & returns would reduce. High volatility generally corresponds to probability of declining market.
• Inflation risk: higher prices can lower the purchasing power of the investments & if the investment returns doesn’t exceed the inflation then the investor tend to lose the purchasing power. For example, $1,000,000 in bonds with a 10% coupon might generate enough interest payments for a retiree to live on, but with an annual 3% inflation rate, every $1,000 produced by the portfolio will only be worth $970 next year and about $940 the year after that. The rising inflation means that the interest payments have less and less purchasing power. The impact of inflation risk is that the investor tends to earn a lower return than expected which can result in investor withdrawing the investments.