As a general rule, investing in stocks can yield higher returns than bonds and real estate. However, stocks carry certain investment risks. A successful investor must learn about different types of investment risk.
Risk of investing in shares:
One of the biggest risks for investors in the stock market is economic risk. A bad economy can seriously affect stock market prices and turn against your investments.
Investing in stocks involves business risks. Your investment can literally go down to zero if your chosen company goes out of business or goes bankrupt, but you can reduce this type of risk by diversifying. If you are properly diversified and invested in a wide range of stocks, the risks involved can be controlled or reduced.
If you invest in new or small companies, you may face the risk of rising stocks. Growth stocks are very sensitive to fluctuations in interest rates. Any bad news about a company can send the stock price down sharply.
Managing currency (or forex) risk is essential to successful foreign exchange investing.
Foreign exchange risks or exposures can be classified into three types: transactional, translational and economic risks.
Transaction exposure refers to the extent to which any change in the exchange rate of a currency may affect a firm’s future cash transactions.
The translation exposure refers to the accounting exposure. It measures the impact of exchange rate changes on the financial statements of a group of companies.
Economic exposure measures the impact of exchange rate changes on a firm’s cash flows and profits.
Most companies attempt to minimize exposure to exchange rate fluctuations by using hedging instruments such as forward exchange contracts, money market hedges, futures, options and swaps.