What different types of risk are there?

We hear a lot about ‘risk’ and generally have an internalised idea of what it means, but in finance risk can be specific, it isn’t just about ‘losing money’ or the risk upside where you make money.

Risk comes in different forms and has different effects depending on how you are affected, we’ll take a look at a few kinds.

Investment Risks Investment risk is the risk that on maturity or encashment of a financial product the return is less than expected or is less then actually invested. There are several reasons why investments might not give the expected return, some of these relate to the risks below, but bear in mind there is always a ‘risk of doing nothing’ which is generally a symptom of opting for safer assets that underperform other choices.

Market / Systemic Risk If there is a general fall in value on the stock markets, or in whatever market you invested in. We have seen many of these in prior years, gold had a huge downside risk for buyers in the late 70’s when prices …

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Credit Default Swaps

Credit Default Swaps (CDS’s) are an over the counter (not bought or sold through an exchange) product which gives the buyer insurance in the case of a credit event (default) of the underlying (reference entity: often a bond). Effectively this brings together a long and short. The video below does a good job of explaining much of this, well worth watching.

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Understand 'Risk' and the different types of Risk

People inherently understand risk. Would you jump from one rooftop to another? I wouldn’t because its risky. Risk is a concept that puts a measure on the probability of certain outcomes, normally with negative connotations, for instance ‘we risk winning everything’ is less likely than hearing ‘we risk losing everything’.

Uncertainty and risk are related but not one in the same, for instance you can be uncertain as to who will win a football match, but it poses no risk (unless you have bet on the game!). Uncertainty can also have upward effects, for instance house prices in the future were uncertain in 1998 from that point until 2006 they rose, from 2006 to present they have fallen. It is still uncertain where prices will end up. The ‘risk’ however of buying in 1998 is almost non-existent whereas the ‘risk’ of those who bought in 2006 is very tangible, many of these people are in negative equity. What they have witnessed is ‘Economic Risk’.

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Understand ‘Risk’ and the different types of Risk

People inherently understand risk. Would you jump from one rooftop to another? I wouldn’t because its risky. Risk is a concept that puts a measure on the probability of certain outcomes, normally with negative connotations, for instance ‘we risk winning everything’ is less likely than hearing ‘we risk losing everything’.

Uncertainty and risk are related but not one in the same, for instance you can be uncertain as to who will win a football match, but it poses no risk (unless you have bet on the game!). Uncertainty can also have upward effects, for instance house prices in the future were uncertain in 1998 from that point until 2006 they rose, from 2006 to present they have fallen. It is still uncertain where prices will end up. The ‘risk’ however of buying in 1998 is almost non-existent whereas the ‘risk’ of those who bought in 2006 is very tangible, many of these people are in negative equity. What they have witnessed is ‘Economic Risk’.

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