Ramblings on Risk (Part 3)

So what are the different kinds of risk do we face?

Financial risk comes in many varieties, but it boils down to not being able to get your money when you need it.

If an asset can’t be easily converted into cash, that’s liquidity risk. For example, a home may be a great place to live, but it takes a while to sell one. By contrast bank deposits are usually available the same day.

We know about credit risk. That’s the risk that a loan you made won’t come back. Anyone can go broke—companies, cities, people—if they lose enough money. And the main way people lose money is through business risk. Business risk is the risk that people won’t buy your product or service at a price high enough for you to make a profit. If this happens on a large enough scale you’re out of business.

That may be because the inputs cost too much, or because your competitors can undersell you if they have an undervalued currency. You may have currency risk without ever selling overseas. Currencies can fluctuate for lots of reasons, and one of the most common is unexpected changes in interest rates. Interest rate risk affects borrower payments and bond prices.

Which brings us to price risk—the variability in an asset’s value. All these other risks affect asset pricing. As risk goes down, asset prices go up, but return potential goes down, too.

Risk is like a diamond. It’s hard and has many facets. But also like a diamond, it can be a great source of wealth.

Douglas R. Tengdin, CFA
Chief Investment Officer
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