Sources of Risk in Business Investment

Sources of Risk in Business Investment:- If we talk only about return on investment without talking about the risk on investment, it will not be sensible. Return on investment and business risk always move together and at any stage of your business life cycle, your return may turn into loss. So it is really important to know about all the sources of risk that may impact your business. There are certain sources of risks that make financial asset quite risky.

1. Interest rate Risk
2. Market Risk
3. Inflation Risk
4. Business Risk
5. Financial Risk
6. Liquidity Risk
7. Exchange rate Risk
8. Country Risk

Sources of Risk in Business

1. Interest rate Risk

Interest rate risk is referred to variability in returns of a security which result from changes in the level of interest rates. Generally securities are inversely affected by such changes. This means that the price of security moves inversely to the interest rate provided other things being equal. Bonds are more affected by interest rate risk than common stocks but normally both are affected by interest rate risk and it is very significant factor of sources of risk for many investors.

2. Market Risk

Market risk is considered as the variability in the returns as a consequence of fluctuations in the entire market or aggregate stock market. Mostly common stock is more affected by market risk but all other securities are also exposed to that risk. There is wide range of exogenous factors associated with the securities that are included in the market risk like wars, recessions, changes in the consumer preferences, structural changes in the economy etc.

3. Inflation Risk

The purchasing power risk is the factor that affects all the securities. It also refers as the likelihood that the purchasing power of the invested dollars will fall. Even if the nominal return is safe, the real return involves risk with uncertain inflation. The risk is associated with the interest rate risk because the increase in inflation results in the increase in the interest rates. The reason behind this fact is that additional inflation premiums are demanded by the lenders in order to compensate for the loss of purchasing power.

4. Business Risk

Business risk is the risk of conducting business in certain industry or environment. For example the traditional telephone powerhouse AT&T confronts many challenges in quickly changing telecommunication industry.

5. Financial Risk

The utilization of debt financing by companies includes the financial risk. When more assets of the company are financed through debt then the variability in the return is enhanced provided other things keep equal. Financial leverage is associated with the financial risk.

6. Liquidity Risk

The risk connected with certain secondary market in which there is trading of security is considered as liquidity risk. An investment that can be sold or brought immediately and without any important concession in price is regarded as liquid. When there is high uncertainty about the time aspect arid the concession in price, the liquidity risk is high. There is little or no liquidity risk for the Treasury bill while the over-the-counter (OTC) stock contains sufficient liquidity risk.

7. Exchange Rate Risk

Exchange rate risk is associated with international investments in which the returns gained in other countries are converted back into the local currency which creates uncertainty. In old days, the US investors did not take into account the international investment alternatives but in current days the exchange risk must be identified and understood by the investors. The variability in returns on security as a result of fluctuations in currency is referred to as exchange rate risk. Exchanger rate risk in also regarded as currency risk.

For example, when US investor purchases German stocks designated in marks. He must finally convert back the returns of the stock into the US dollars. If the exchange rate is not in favor of the investor than the losses from the movements of exchange rate can partially or completely counterbalance the originally gained returns.

8. Country Risk

In current years, country risk is regarded as one of important risk for investors. While investing internationally, the investors should consider the political and economic stability & viability of the country. Countries should be judged on relative basis by considering the United States as a benchmark because of its lowest country risk. There are certain examples of countries that required careful monitoring in 1990’s because of country risk like China, Hong Kong, former Soviet Union, Smith Africa and Yugoslavia. Moreover there are certain other countries that require careful attention in the early decades of the twenty first century like Turkey, Russia, South America and Hong Kong etc.