Risk & Return

Every investment carries some level of risk. Understanding different types helps in making informed decisions. Systematic Risk (Market Risk): • Affects entire market or economy • Cannot be eliminated through diversification • Examples: Recession, inflation, interest rate changes, political instability • Beta measures sensitivity to market risk Unsystematic Risk (Company-Specific Risk): • Affects individual companies or sectors • Can be reduced through diversification • Examples: Management changes, product failures, labor strikes • Also called diversifiable risk Specific Risk Types: 1. Credit Risk: • Risk of default by borrower • Higher in corporate bonds vs government bonds • Credit ratings help assess this risk 2. Liquidity Risk: • Difficulty in selling investment quickly • Higher in small-cap stocks and bonds • Can lead to forced selling at lower prices 3. Inflation Risk: • Erosion of purchasing power over time • Fixed-income investments most affected • Real returns = Nominal returns - Inflation 4. Currency Risk: • Exchange rate fluctuations • Affects international investments • Can be hedged through derivatives 5. Interest Rate Risk: • Bond prices move inverse to interest rates • Longer duration bonds more sensitive • Affects all fixed-income securities