Risks can arise from numerous factors and can often get compounded into multiple types. In this chapter, we categorise financial risks into the following types.
Types of financial risk
Credit / Default Risk
Default refers to the act of not paying on time or not paying at all. All your loan or debt-related investments carry the risk of default.
Liquidity refers to the benefit of investment to be quickly converted into cash. For example, FDs have high liquidity as they can be broken and withdrawn whenever the need arises. Whereas investment in real estate property like an apartment has less liquidity, it usually takes some time to sell.
Operational risks are associated with the operations of the entity where we have invested. Let’s assume that we hold equity shares of a particular company. The company’s management makes poor business decisions and losses are operational risks. These risks can affect our return in the form of lesser dividends.
Interest Rate Risk
Interest is the return on many investment products and the cost for loans. Fluctuations in the interest rates can affect the income or increase the cost of investments—for example, the home loan interest rate rising from 10% to 10.50%.
Foreign Exchange (Forex) Risk
These risks arise out of the volatility of the values of currencies in the forex market. The strengthening and weakening of the Indian Rupee against foreign currencies will affect your investment in forex. These risks may also impact investments that are indirectly related to forex.
These are the risks of change in policies by regulatory authorities like the RBI. For example, you have invested in Bitcoins, and the RBI bans the trade of cryptocurrencies.
All these risks can impact the returns on your investments. Hence, it would be best if you considered them before investing.