Risk and Portfolio Context Essay Example | Topics and Well Written Essays - 1500 words

Risk and Portfolio Context - Essay Example Risk is a core element of investment and is inseparable from investment function. According to investment theories and actual practices, it is evident that there is no possibility of return over the investment without the assumption of risk in that investment by the investor. A conscious and willing assumption of risk by a knowing investor, expecting to earn a measure of return, lies at the heart of investment process (Sedleck, 2008, pp.1). Webster defines risk as â€Å"the possibility of loss or injury† (Sedleck, 2008, pp.3), in investment risk is the possibility of monetary loss through the loss in value of the investment instrument. Risk is a subjective measure with many possible definitions. This is because different investors adopt different investment strategies to attain their investment objective. Therefore, the subjectivity of the risk is its only main characteristic. It is an unavoidable function of investment, intelligent investment strategies can help to reduce it but nothing can help to ignore, negate or make risk zero (Sedleck, 2008, pp.3). Types of Investment Risk Investment risks are of two types systematic and unsystematic, however, they hole various other kind of risk in these two head branches of risk. The risks associated with investments are as follows: Systematic Risk It is the market risk, related to the factors the complete market economy or securities market. This kind of risk is beyond the control of the investor. As it is a market risk, it affects all the companies in the market irrespective of the company financial position, capital structure and management position. It involves domestic and international factors, depending upon the kind of investment (FINRA, 2013). Types of Systematic Risks Interest rate risk is the risk that due to change in interest rate over time will result in value of security going down (FINRA, 2013). Inflation Risk is the risk of decrease in purchasing power due to increase in prices of goods and services and cost of living (FINRA, 2013). Currency Risk arises due to world currency floating against each oth er. The reason for this risk is the change in exchange rate. Change in exchange rate can affect the return on a foreign currency investment in positive as well as negative way. This risk occurs only in circumstances of investment in international securities and funds (FINRA, 2013). Liquidity Risk is the risk that an investor might not be able to purchase and sale investments quickly at the price that is close to the actual underlying value of that investment. It is higher in over the counter markets and small-capitalization stock (FINRA, 2013). In case of foreign investment the timing of dealings, market size and number of listed companies can affect an investor’s ability to buy or sell foreign investment (FINRA, 2013). Socio-political Risk is the risk of adverse effect of instability and unrest in one or more region of the world on the investment market (FINRA, 2013). Defence against Systematic Risks An investor’s defence against systematic risk is the strategy of ass et allocation. This strategy dictates that the investor should build an investment portfolio with such investments that react differently to same economic factors. It involves investing in bonds as well as