What is risk and what are the types of risks in the capital market?

What is risk?

Perhaps one of the factors that prevents people from achieving success in life is the fear of taking risks. In financial markets, unlike traditional markets and businesses, the amount of risk we want to take can be measured more accurately, but to begin with, we must first see how many types of risk we have in financial markets such as the stock market.

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What is the meaning and concept of risk?

It can be said that in the minds of most people in society, the word risk equals danger and perhaps destruction, but we must keep in mind that risking is not always dangerous, but risk in the general sense of “uncertainty” of the future. . We may take risks in something and face positive opportunities that will change even our future. These positive opportunities are clearly visible in financial and investment concepts, so it can be concluded that risk has two positive and negative dimensions.

What are the risks in investing and financial markets?

In general, risk can be considered one of the most widely used concepts in everyday life, so that in your personal or work life, for every decision you make, you should pay attention to the risk and consequences of that decision, but in today’s world, the concept of risk in financial matters And more investment is being made, and people around the world are increasingly looking to measure risk in decisions that address their issues.

Why is there a risk and what are the two main types?

From the beginning of humanity and civilization on Earth, we have always been faced with dangerous and unknown factors and there has always been the possibility of our harm and even destruction, so humans have learned over thousands of years that events and happenings Predict the bad and be prepared to deal with them. As we progress and become more intelligent, the decisions we have to make become more and more complex, and this puts us at greater risk.

In general, the risk situations in which we find ourselves fall into two general categories:

Real or net risk

These risks are in fact physical dangers such as accidents, fires, earthquakes and natural disasters, diseases, etc., which are mostly not available to us and threaten our lives and if they occur, they will result in nothing but damage and destruction. In today’s life, these risks are generally insurable so that in the event of minimal financial losses due to their occurrence can be compensated.

Dynamic or speculative risk

This type of risk, which occurs mostly in financial matters and the subject of our article, is measurable and the possible consequences can be profit or loss. This type of risk applies to a variety of investment issues, economics, betting games and the like.

Classification of people in terms of risk

Investors can be divided into three categories in terms of risk acceptance capacity:

Risky

These people act boldly and take more risks in order to make more profit.

Risk aversion

These people have a conservative approach in a way that they prefer to have better and lower returns instead of being more likely to succeed.

Neutral or indifferent

For these people, it can be considered as the middle of the above two groups.

In general, risk-taking and risk-aversion do not mean taking risks and escaping from risk, but it does mean that risk-takers expect less reward per unit of risk than risk-averse people, ie if in a case with risk Equally, if we want to convince a risk-averse person and a risk-averse person, we must promise more rewards to invest in a risk-averse person.

What is a portfolio?

You may have heard the saying that you should not put all your eggs in one basket, this proverb in the market means that you should have a basket of assets for your assets and investments. And consider investing in different cases. By considering different items in your portfolio as well as your investments, you reduce your investment risk. Of course, it should be noted that if you have a diversified stock portfolio, you will not suffer much damage in the face of non-systematic risks, but You are vulnerable to systematic risks, so you should not bring all your assets to the stock market, for example, but you should have a portfolio of assets.

Diverse portfolio samples

Sample portfolio

Basic types of risk

When we talk about risk in the capital market, we are faced with two main types of risk.

Systematic risk (unavoidable)

Risks that are not in the hands of you or investors are called systematic or unavoidable risks. This risk is related to the macro-political and economic conditions of the country, which can not be eliminated and systematically affects the entire market and is not limited to a specific industry. These types of risks include war, economic and political sanctions, interest rates, inflation, exchange rates, and so on. In this type of risk, it does not matter from which industries you have chosen your portfolio, all industries will lose.

Unsystematic risk (avoidable)

Unsystematic risk is also known as (avoidable, definite or eliminable risk) which can be measured and avoided in some ways. This risk is a type of investment risk that is unique to the particular company or industry in which you invest. This risk relates to news specific to a particular stock or industry, for example, when petrochemical feed rates or component import tariffs change, these changes affect affiliates. This risk can be reduced through diversification and portfolio formation. In a well-arranged portfolio, the risk of such cases is very small and only systematic cases affect this portfolio.

The concept of risk to Rivard

The concept of risk to reward is one of the most important concepts of financial markets that every analyst, trader and investor in stock markets, Forex, digital currencies or other financial markets should be familiar with.

Risk to Rivard means how much profit I make for each unit of risk I take. For example, we teach our students in the stock market that we should make at least five units of profit for each unit of risk, that is, if 10 You want to invest a percentage of your cash capital on a stake, you must earn at least 50% of your capital.

Types of risks to consider

financial risk

The risk that a company will not be able to meet its obligations is called financial risk. The higher the financial liabilities and loans received by the company, the less the company’s ability to develop and expand and increase profitability. This type of risk is called financial risk. This risk is somewhat systematic and predictable. This risk is reduced by better researching and knowing the company in which we intend to invest. It should not be forgotten that this research only reduces the probability of this risk, not reduces it to zero. This type of risk exists in the stock market even in dynamic economic conditions.

Interest rate risk (interest rate)

This type of risk arises if we are in a situation where there are several options for investment. For example, if we doubt between investing in stocks or bonds, the difference in interest rates between the two investments can lead us to one of them. For example, if buying stocks is 25% profitable for us, we have fixed interest bonds that are 20% profitable for us. If it increases to 25, then it is cheaper to buy bonds with less risk than stocks. This type of risk usually affects partnership bonds and bonds more.

Market risk

This type of risk is one of the issues that we face daily in the financial markets, especially the stock market. This type of risk is also referred to as the levels of support (demand) and resistance (supply) of the market. The stock market consists of several hundred thousand investors who enter the stock market with different approaches, and it is the sum of the buying and selling decisions of these investors that constitutes supply and demand in the market. When a large number of these investors decide to buy a particular stock, demand for that stock will pay off, and if supply is low for it, the price of the stock will pay off, and vice versa. High supply and lack of demand for purchase drop day by day. These sharp fluctuations are part of the market, which is called market risk.

Inflation risk (purchasing power risk)

Inflation is the devaluation of the country’s currency, which means that we have to pay more to buy a good or service than in the past. This risk has a direct impact on the return on our investments because the net profit from an investment is equal to:

Suppose an investment is 40% profitable for us. If the inflation rate in the country is 5%, the net profit of this investment is 35% for us. As the inflation rate increases, the attractiveness of this investment decreases. For example, suppose that the inflation rate in the country becomes 30%. In this case, this investment may no longer be attractive to you, so you should look for investments that Its profit after tax is attractive. This type of risk that is imposed on people due to rising inflation is called inflation risk.

Political or governmental risk (country or geopolitical risk)

This risk is a subset of systematic risks. Instability in the political situation of the country can have destructive and bad effects on the economic situation of the country and the performance of the country’s economic enterprises, and the more this instability is, the more difficult the performance of these enterprises will be. Political risk can include political instability, war, changes in government laws, and the like. It is important to note that the longer and longer the investment horizon, the greater the risk and the greater the need for careful investment.

Personal risk

We must keep in mind that we should not always know the source of risk as the market. Sometimes the risk of direct investment is related to the investor himself. This risk can be the result of impatience or haste of the investor. Suppose you have bought 100 million Tomans of shares of a company with a 5-year vision. Ironically, these shares will decrease in price by 10% after a period of time, and at the same time you will sell these shares due to the need for money and liquidity. Stocks grow right after your sale. This lack of planning or rashness and impatience in investing is one of the important risks in investing that we must be careful about. We may be able to minimize all unsystematic risks by providing a diversified portfolio and managing the weight distribution of capital, but personal risk is a function of the investor’s misguided actions, which is entirely up to him.

Emotional risk

This risk, the main source of which is the feelings and emotions of traders and investors, includes fear and greed. Greed or a kind of false hope occurs when we buy a share at the price of 500 Tomans and the analysis we have done is that the share reaches the price of 800 Tomans in approximately two months, but what happens is that the share It will reach this price in two weeks and our sales time will reach according to our analysis, but we will have false greed or hope and we will tell ourselves that it will definitely go higher until it comes to this speed, and this is exactly the time when We fall into the trap and the price goes back and we lose some of our profits. In contrast to this feeling, there is a feeling of fear that according to the analysis, we buy a share and set a 10% loss limit for ourselves. In two cases, we may sell this share due to unnecessary fear. First, within a few days after the purchase. The price goes fast towards our loss limit and we sell our stocks due to fear before reaching the loss limit. In this case, the price may return and rise before reaching our loss limit. The second case is that we are in profit, but the price has not yet reached our price target, and the price will be negative for a few days, and some of our profit will decrease, and we will sell the share at a low profit for fear, if if we wait, the price will rise again. It could be and we could sell the share at our desired price.

Liquidity risk

It is desirable to have assets and investments that have high liquidity. If an asset or investment is not easily sold, the holder faces the risk of liquidity. This liquidity is different in different markets. For example, if you invest in the real estate market, you may not be able to quickly find a customer and sell your assets at the time of sale, but when you have stocks, you can stock them in one day. Sell and convert it into cash, but this risk also exists in the stock market. Suppose you want to sell a company’s stock in the market, but because of the company’s poor performance, no one buys the stock. In this case, you run the risk of being liquidated. The faster a stock is traded and the smoother its trades, the less risk there is.

Exchange rate risk

In the case of import-oriented and export-oriented companies, exchange rate risk is very important, and of course its impact on these companies is very different. If your company imports most of its raw materials and equipment from abroad, with the growth of the exchange rate, it will suffer a lot of losses, and this, in addition to increasing the company’s costs, will reduce their profitability and even losses in a period of time. (Of course, after a period of time with legal licenses, they increase their selling price and the situation becomes normal) during this period, this world makes investors reluctant to buy the company’s shares, and as a result, the shares fall in On the other hand, export-oriented companies make good profits from the increase in the exchange rate, and the public acceptance of buying their shares increases. This risk is a non-systematic risk that cannot be controlled by companies.

Business risk

In this risk, the issue is considered whether the company is able to sell its products and cover its operating costs? Can it compete with domestic and foreign competitors in the market? This risk takes into account all the costs of a business to stay operational. These costs include salaries, production costs, rental of facilities, office and administrative expenses. A company’s level of business risk is affected by factors such as the cost of goods, profit margins, competition, and the overall level of demand for the products or services it sells.

Credit risk

Credit risk is the inability to repay interest or debt. This type of risk is more worrying for bond investors. Bonds have the lowest amount of credit risk and have the lowest yield. In contrast, corporate bonds have the highest amount of credit risk and therefore higher interest rates and interest rates. This risk is also present in mutual funds and you should consider different conditions when choosing the type of fund you want to invest in, for example, fixed income funds have the lowest investment risk, but their annual profit is also in It is about 20% in contrast to equity or mixed funds have even higher returns than market returns.

Country risk

Country risk is the inability of a country to pay its government financial obligations to its subsidiaries or contractors. In the event of such a risk, the performance of other financial sectors of the country will be damaged. Damage to other countries in connection with it is also possible. This risk occurs in most developing countries with severe budget deficits.

Conclusion

In this article, we are introduced to the definition of risk. We talked about its origins throughout history, understood what risk means in normal life and financial markets, and introduced you to its basic types. We got acquainted with different types of personality in the face of risk and explained to you the types of risks in financial markets, especially the stock market.

What is risk?

What is the meaning and concept of risk?

What are the risks in investing and financial markets?