Investments. Investment risks (most important)

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Investments. Investment risks (most important)

Lecture notes, cheat sheets

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INVESTMENT RISKS

Investment risk - this is the risk of depreciation of capital investments due to the actions of state authorities and management. The purpose of investment portfolio management is to increase its market value. An important criterion for selecting portfolio shares is the level of return on shares. But a high expected return is associated with a high risk of not receiving it or the risk of losing the invested capital. When managing an investment portfolio, a full assessment of its level of risk is carried out, then the level of profitability of the investment portfolio is planned.

Classification of investment risks:

1) systematic (market) risk: the risk of changes in the interest rate; currency risk; inflation risk; political risk;

2) non-systematic risk: industry risk; business risk; credit risk.

Systematic (market) risk called the risk arising from external events that affects the market as a whole:

▪ interest rate risk - the risk associated with a change in the interest rate by the country's central bank. When the interest rate decreases, the cost of loans that companies receive decreases and their profit growth increases, which is favorable and promising for the stock market. Conversely, an increase in the interest rate negatively affects the market;

▪ inflation risk - this type of risk is caused by rising inflation. It reduces the true profit of companies, which negatively affects the market, and also causes the emergence of another risk - the risk of changes in the interest rate;

▪ currency risk - the risk arising due to political and economic factors taking place in the country;

▪ political risk - this is the threat of a negative impact on the market due to political actions (change of government, war, etc.).

Here, it is important for the investor to evaluate not so much the risk of each security as the entire market risk. Systematic risk cannot be mitigated by diversifying stocks, since the different types of risks included in it affect all stocks at the same time.

Unsystematic risk, or the risk that can be reduced through diversification, is determined by events affecting only one given firm.

Unsystematic risks include:

▪ industry risk - the risk associated with the influence of industry-wide factors on the company;

▪ business risk - the risk associated with production efficiency and its management by the management of this company;

▪ credit risk arises when capital or part of it is formed at the expense of debt obligations (for example, when a credit rating is lowered and the prices of corporate bonds placed on the market are caused to fall, and also entails an increase in the cost of a bank loan).

Author: Kuznetsova S.A.

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