Skip to main content

Various Risks in Investing

Investing requires us to choose between eating well and sleeping well. If you want to eat well, be ready to take on the risks involved in seeking higher returns. If sleeping well is what you are more concerned about, be ready to give up higher returns in exchange. But in either case defining risk only in terms of the probability of losing money is not enough. Risk comes from various sources, so it is important to understand the different types of risks that come to the fore while picking an investment.

Financial risk :
Interest being tax-deductible, equity shareholders welcome debt to the extent it enhances their returns. But beyond a point, they are exposed to the risk arising from a high level of fixed commitments. This describes financial risk. It arises when debt represents a higher proportion of a company's capital structure (comprises net worth and debt).

Exchange rate risk :
This is the risk arising from changes in exchange rate of the rupee versus the US dollar or any other currency. Profits of companies who import a relatively large part of their raw material are at risk if they are not able to fully pass on cost increases when the rupee depreciates. A weakness in the rupee also prompts foreign investors to withdraw from the stock market by selling their shares and converting those rupees into dollars. While they may re-enter at lower levels, that stock indices tumble in the short-term is a big risk for the domestic investor.

Industry risk :
It is the risk applicable to an industry. A large scale shift in demand, a rise in input prices, regulatory changes are typical factors that would signify such a risk. For example, a shift in demand for generic medicines compared to innovator drugs would pose a big threat to big pharmaceutical majors globally. Or, a shift in trucks from single-axle trucks to multi-axle trucks will pose a major threat to companies unable to produce the new type of trucks.

Inflation risk :
Inflation can hit a company's profits if it is unable to pass on higher costs to consumers. This trouble is often faced by large manufacturing concerns and public sector units through wage hikes that occur due to inflation. They are not easy to pass on. Even if inflation eases, wage hikes can rarely be rolled back. Worse, inflation can inflate corporate profits through overvaluation of closing inventory. When a company uses the FIFO (first in, first out; where the material that is issued first is priced on the basis of the cost of material received earliest) method to value inventory the charge to production is low in a period of rising prices. This can inflate reported earnings, increase tax burdens and may prompt a higher dividend---consequently the company is financially weaker.

Interest rate risk :
Since they come with a fixed return, bond values fluctuate with changes in interest rates. When interest rates rise, the value of an existing debenture goes down, as it is paying a lower rate than what investors could earn elsewhere. When interest rates fall, the value of a debenture rises as they are now earning a higher rate than what investors could earn from one that is newly issued. The longer the maturity of a bond, the greater is its vulnerability to an interest rate risk.

Management risk :
It is simply defined as the inability of the management to take decisions in the larger good of its minority shareholders and the company. All decisions that benefit only a company's directors and its promoters would classify as a management risk. But even a shareholder-friendly management can be a risk if it is unable to manage a company's growth in both good and bad times or if it lacks the dynamism needed to lead a company.

Business risk :
It is the variability of a company's earnings before interest and taxes (EBIT). It is a combination of the following: one, change in demand. If demand for a product/service is not stable or predictable, its revenue won't be stable or predictable either. Next is the company's ability to increase prices or absorb cost increases, which is crucial to sustain profitability. Companies differentiating their products through branding are better equipped to pass on cost increases and earn above average profits. Third, if fixed costs are a substantial portion of total costs, business risk is definitely higher (unless such a cost also creates a strong entry barrier) since a company's earnings then are more susceptible to variations in demand and prices.

Market/Economy risk :
Risks that are common across companies are known as market/economy risk: economy-wide factors like money supply, level of government borrowings, changes in industrial policy, a global recession and so on. It is also known as non-diversifiable risk, since investors cannot avoid the risk arising from them, however diversified their portfolios may be.


Popular posts from this blog

Your Bill Amounts Are Going To Increase From June 1, 2016

Service tax is a tax levied by the government on service providers on certain service transactions, but is actually borne by the customers. It is categorized under Indirect Tax and came into existence under the Finance Act, 1994. Union Finance Minister, Arun Jaitley, in his budget announcements proposed to impose a cess, called the Krishi Kalyan Cess, @ 0.5% on all taxable services. The present rate of service tax will be hiked to 15 per cent from June 1, 2016, from 14.5 per cent. Take a look at what gets expensive:

Phone Bills: Your phone bills are going to go up. So, pay a good 15 per cent now on service tax on phone bills.

Restaurant Bills :If you are dining in a restaurant that already has service tax applicable, you are going to pay more on your eating out. Though 0.5 per cent on a single bill may not mean much, frequent diners may end-up paying a lot during the year.

Travelling: You will have to pay more for air travel, as there is a service tax on tour operators and travel agents.

What is Gold ETF - Gold Bees, Reliance Gold,Kotak Gold

What is Gold Bees or Gold ETF?

Gold ETFs are open-ended mutual fund schemes that will invest the money collected from investors in standard gold bullion (0.995 purity). The investors' holding will be denoted in units, which will be listed on a stock exchange.They provide returns that would closely track the returns from physical gold in the spot market.

An investor can buy and redeem the units either directly from the mutual fund or from the stock exchange.Presently there are many Gold ETFs traded in NSE India. Some of the listed Gold ETFs are GoldBees,Reliance Gold,Kotak Gold,UTI Goldshare

Why choose Gold?
Gold holds its own in any investment evaluation on its strengths as a hedge against inflation, value in the event of political uncertainties and its traditionally negative co-relation with other asset classes such as stocks, fixed income securities and commodities.

The value of goods and services that gold can buy has remained stable unlike currencies that have seen significant…


NIFTY BEES - is the first ETF (Exchange Traded Fund) in India, which seeks to provide investment returns that closely correspond to the total returns of securities as represented by the S&P CNX Nifty Index. It gives you the most diversified exposure at lowest possible unit size. Approximately value of Nifty bees will be 1/10th value of the prevailing Nifty price.

ETFs are one of the latest financial innovations and any new concept takes time to be known widely. Globally it took more then five to seven years before it could be of any significant size. In India, it was introduced with Rs 21 crore in size , a fraction of the mutual fund industry, it has come far with more than Rs 700 crore in size with six ETFs.

The Nifty BeES also scores over other index funds due to its low tracking error and expense ratio, apart from easier tradeability as it is listed in the NSE. One can also consider doing an SIP in Nifty BeES.

Some of the reasons to invest in Nifty Bees : Investing in Exchange …