Risk #1

The standard by which any investment should be judged is not just how much can be made from it if all goes well. Rather, it is how much can be made in relation to the amount of risk involved.

There are several types of risk that can be included in the risk. Usually, it is difficult to quantify what percentage of the risk is associated with each type of risk.  There are three risks that affect the amount of the risk : counterparty risk, liquidity risk, and interest rate risk.

1. counterparty risk
Counterparty (default) risk is the chance that the borrower will not be able to pay the interest or pay off the principal of a loan. This risk can influence the level of interest rates. It is generally considered that U.S. Treasury securities have no default risk the U.S. government will always pay interest and will repay the principal of its borrowings. Therefore, the difference in price between a U.S. Treasury security and another corporate bond with similar maturity, liquidity, etc. may be the risk premium for assuming counterparty risk.

2. liquidity risk
Liquidity refers to the marketability of assets – the ease with which assets can be sold for cash on short notice at a fair price. Investors may require a premium return on an asset to compensate for a lack of liquidity.

3. interest rate risk
Interest rates indirectly impact stock prices through their effect on corporate profits. The payment of interest is a cost to companies – the higher the level of interest rates, the lower the level of corporate profits Interest rates affect the level of economic activity which, in turn, affects corporate profits.

The effect of interest rates on corporate profits is more important companies, especially those with high debt levels.