Generally, investing in stocks can generate higher returns than bonds and real estate. However, stocks carry certain investment risks. A successful investor should learn about the different types of investment risk.
Equity investment risk:
One of the biggest risks for stock market investors is economic risk. A bad economy can seriously affect stock prices and backfire on your investment.
Investing in stocks is subject to business risks. Your investment can literally drop to zero if your chosen company fails or fails, but you can reduce this type of risk through diversification. If you are properly diversified and invested in a wide variety of stocks, the associated risks can be controlled or reduced.
If you invest in new or small companies, you may be exposed to growth stock risk. Growth stocks are very sensitive to changes in interest rates. Any bad news about the company can cause the stock price to drop significantly.
Foreign exchange (or forex) risk management is essential for a successful investment in the foreign exchange market.
Currency exposure or risk can be categorized into three types: transaction, conversion and economic exposure.
Transaction exposure refers to the extent to which the company’s future cash transactions may be affected by any change in the exchange rate.
Translation risk refers to accounting risk. It measures the impact of changes in exchange rates on the financial statements of the group of companies.
Economic exposure measures the impact of exchange rate changes on a company’s cash flow and earnings.
Most companies try to minimize the risk of exchange rate fluctuations by using hedging instruments such as forward exchange contracts, money market hedges, futures, options and swaps.