Risk Involved in Investing


By
Ms. Sonal Goel
MBA III Sem (Finance)
Banasthali University (Raj.)
Category A University (MHRD, GoI)
Ranked 6th nationwide on factual data (AC Nielsen-India Today, August 15, 2011)
NAAC A Grade (2003)
 


A) Concept of Risk

Risk pertains to a probability of earning lesser return than expectations. It is a probability of loss due to unforeseen reasons. There is an opportunity cost which is involved in every investment. It has been said theoretically, that there is no risk involved in Bank FD's, but if we see practically there is some risk; what will happen if bank becomes bankrupt? So risk is associated with each and every investment.

B) Strategies Adopted by Investors

There are basically three strategies that have been adopted by investors while making investments:-

1. LOW RISK STRATEGY

These are adopted by long term investors who want to have minimum or least risk in investments. For this investor may invest in Bank FD's, Government Securities, Provident Fund, Post office Schemes or can invest in Mutual Funds of low risk category i.e. in Balanced Mutual Fund category.

2. MEDIUM RISK STRATEGY

These are meant for medium term investors who are investing for medium time period and are ready to bear little bit higher risk to have more returns in comparison to investors opting for low risk strategy. Investor; for this can invest in equity based Mutual Funds like Diversified Mutual Fund schemes. Investor can go for Gold ETF Schemes, SIP (Systematic Investment Plan) schemes for investment purpose. Risk and return are commensurate and go hand in hand.

3. HIGH RISK STRATEGY

Investors having ambitious financial goals are lured by higher risk strategy. In this investor invests for short period of time that is they invest in share market and do trading of stocks which is very risky investment. Investors do investment based on opportunity that is they revise their portfolio, if they seek opportunity or higher return in other securities for a time period. For this, investor can go for investment in individual stocks or in sectoral Mutual Funds schemes.

C) TYPES OF RISK

1. SYSTEMATIC RISK

Those risks which are inherent in nature and are not controllable. These are non- diversifiable risks. This type of risk affects everyone because of raw happenings in the economy of country and world.

2. UNSYSTEMATIC RISK

Risks which are controllable and are not market specific and are diversifiable i.e. risk can be diversified by doing investment in varied securities.

The relation between systematic and unsystematic risk can be clear with the help of following graph:-


Explanation:-

It has been said that, "Don't put all your eggs in one basket".

So, the same has been followed here that is firstly, we see in initial stage, the risk falls steeply as we increase no. of securities in portfolio but gradually rate of fall in risk reduces and finally becomes flat due to uncontrollable factor, no matter how much securities are invested in profit.

D) REASONS FOR SYSTEMATIC RISK

1. POLITICAL CONDITIONS

When political conditions are adverse and thus create an adverse situation for an economy like what is happening nowadays, "Anna Hazare Protest for Lokpal Bill".

2. SLOWDOWN

Presently, global slowdown is hurting stocks, economy worldwide. As, it depends on the nature of policies of one country with respect to other i.e. how much one country has opened gates for other country in terms of trade. If large gates are opened than economy will be affected, if anything bad happens to another country economy with whom trade is being done.

3. RISE IN INTEREST RATES

When interest rates increases then also economy becomes uncontrollable as investor prefer less to take loans and if they don't take loans then they can't do investing or if so also do investing, risk will not be controlled and returns remains risky.

4. RISE IN INFLATION

With the rise of inflation, purchase power will be decreased and everything will be costly like what is happening today as India's inflation rate is over 9% but 5-6% is the desired level of inflation rate for the developing economy.

E) REASONS FOR UNSYSTEMATIC RISK

1. INDUSTRY SPECIFIC

At a particular point of time, particular industry may not do well so this will impact all the concerned companies. Like, Sugar Industry is suffering a lot due to Government interference and prices of the same have also been influenced by government policies. During this situation, risk can be avoided by taking less exposure in that particular industry and explore other non-risky or less risky industries for investment.

2. COMPANY SPECIFIC

It pertains to company's situation. An industry may be doing well but it is not necessary that company will also do well. Like, quality problem was found once with Ranbaxy but it was not the case with Cipla. So, these risks are company risks.

F) MEASURES OF RISK

1. STANDARD DEVIATION

It quantifies the degree to which returns fluctuates around their average, a higher value of standard deviation means higher risk. It determines the volatility of funds. High standard deviation implies high volatility and low standard deviation implies low volatility.

2. BETA ANALYSIS

It is used to measure the risk. It basically indicates the level of volatility associated with the fund as compared to the market. Higher the beta, higher the risk. It keeps on changing from time to time.

3. VAR(VALUE AT RISK)

Maximum loss a share is likely to have on a typical trading day. It shows that over a time period what is the highest of probabilities to lose money. It is a popular measure. Higher the VAR more is the risk.

Margin for trading = VAR rate + Additional Volatility Margin

VAR rate is determined on the basis of historical data. Volatility margin is the additional margin for safety purpose.

G) RISK MANAGEMENT

This ensures how the risk can be minimized.

1. Lesser risky assets

Investor to minimize risk should invest in assets which are less risky. They can invest in Mutual Funds to ensure less risk.

2. Diversify

The best thing to minimize risk is to do diversification of securities for investment purpose. This can be done in two ways:-

a) Security/Asset Diversification
b) Time Diversification

Investment can be made in multiple assets/securities. An investor can go for regular and long term investment, as even in the case of worst situation, one will be getting stable returns.

3. Monitor portfolio periodically

An investor has to monitor the shares/portfolio periodically to find out if investments are performing as desired. Monitoring also helps to avoid any unpleasant situation.

4. Take risk that you can afford

Bear the risk that can be afforded and can be managed. It should be done keeping in mind all situations and risk and socio-economic profile of an investor.

So, in this way risk can be minimized and losses can also be avoided.

As, opportunities in world of investments keep on increasing and decision making gets complex, specialized knowledge is a pre-requisite. At the time of writing this article Sensex is at 16000 level while Gold price has dropped by almost 5% indicating the relevance of risk in investment. This article focuses on concept, types and management of risk.

REFERENCES:-

1. Chandra Prasanna (2009): Investment Analysis and Portfolio Management, Tata McGraw, New Delhi
2. Class notes by Dr. Harsh Purohit (Reader, FMS WISDOM, Banasthali University, Rajasthan)
 


Ms. Sonal Goel
MBA III Sem (Finance)
Banasthali University (Raj.)
Category A University (MHRD, GoI)
Ranked 6th nationwide on factual data (AC Nielsen-India Today, August 15, 2011)
NAAC A Grade (2003)
 

Source: E-mail August 30, 2011

 

           

 

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