The types of investment risk
Risk is not one thing
“Risky” is a lazy word. A fixed deposit and a small-cap share are both risky, but in completely different ways, and a distributor who can name the risk is far more useful than one who just says “markets go up and down.” Formally, risk is the chance that your actual return turns out different from what you expected. The upside surprises are welcome; it is the downside we manage.
Some risks come from the wider world. Inflation risk is the quietest and most underrated: leave money somewhere that earns less than inflation and it grows in rupees while shrinking in real buying power. Interest-rate risk is the one that trips up bond investors, because bond prices move opposite to rates: when market rates rise, an older bond paying less must drop in price until its yield matches the new normal. Market (price) risk is the broad tide, sentiment, global events, policy, that can pull an asset’s price down even when nothing is wrong with the asset itself. And currency risk touches anything priced abroad, since exchange-rate moves change what a foreign holding is worth in rupees.
Other risks come from the specific thing you invest in. Credit (default) risk is the chance a borrower cannot pay interest or return your capital; that is exactly why a weaker issuer must offer a higher rate to attract lenders, and why credit ratings matter. Liquidity risk is being stuck, unable to sell in time without slashing the price, the reason property and thinly traded securities are harder to rely on for near-term needs. Concentration risk is the danger of putting too much into one holding, sector or issuer, so a single failure does outsized damage; spreading out is the direct cure. Finally, reinvestment risk is subtler: when a deposit matures or a bond pays interest, you may be forced to redeploy that money at a lower rate than you were enjoying, quietly trimming future income.
The takeaway for the exam and for real advice is the same: name the risk before you judge the investment. Matching an investor to a product is really the craft of matching them to the risks they can live with.
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Risk means the chance your actual return differs from what you expected, in either direction, but investors mostly fear the downside.
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Inflation (purchasing-power) risk is the quiet one, your money grows in rupees but buys less if it does not beat inflation.
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Interest-rate risk hits bonds, when market rates rise, the price of existing bonds falls, and vice versa.
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Credit (default) risk is the chance a borrower fails to pay interest or return capital. Lower-rated issuers pay more to compensate for it.
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Liquidity risk is being unable to sell in time without cutting the price. Real estate and thinly traded securities carry it.
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Market (price) risk is the risk that broad moves, sentiment, events, policy, drag an asset's price down regardless of its own merits.
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Concentration risk is putting too much in one holding, sector or issuer, so one failure hurts badly. Diversification is the antidote.
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Reinvestment risk is being forced to reinvest maturing money or interest at a lower rate than before.
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Currency risk affects anything priced in a foreign currency, exchange-rate moves change your rupee return.
A 10-year bond pays 7%. If market rates jump to 9%, no one will buy your 7% bond at full price, so its market value drops until its yield matches, that is interest-rate risk in action. Meanwhile a fixed deposit that earns 6% while inflation runs at 6% grows on paper but stands still in real buying power, that is inflation risk.
Practice
🔥 0 streakReal exam format. Answer by voice, tap, or press 1 to 4. No negative marking, so always attempt.
Market interest rates rise sharply. What happens to the price of bonds an investor already holds?
An investor keeps almost all of her money in a single company's shares. Which risk is she most exposed to?
A bank deposit earns 6% a year while inflation is also 6%. The main risk the saver faces is:
A five-year fixed deposit at 8% matures, but new deposits now offer only 6%. Renewing at the lower rate is an example of:
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Education for the exam, not financial advice. Answers can be wrong, so confirm figures against the workbook.