WHAT IS RISK?
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In the investment world, risk refers to an uncertain
return on your investment. When you make an investment, you may lose your money,
or at least not see any gains. Generally, people try to match their desired
return with an acceptable level of risk. Some of the specific risks investors
may face include the following:
? Bond default risk. This is
the risk that the issuer of a bond will not be able to meet its debt
obligations. If a company goes bankrupt, you may lose your entire
? Bond horizon risk. Investors view
longer-term bonds as being riskier and therefore demand higher returns. This is
because the prices of long-term bonds are more sensitive to interest rate
? Inflation risk. When you invest in bonds,
there is always the risk that inflation will lower or eliminate the purchasing
power of your returns. Future inflation is always uncertain, and therefore your
real rate of return is also uncertain.
? Equity risk. This is the risk you
undertake when you buy stocks. A stock may lose its value. If the value of a
share falls below the price you paid for it, you are losing money.
? Small stock risk. Market returns for
small stocks are very volatile. Small-cap stocks are stocks in companies with
relatively low funding, or capitalization. Small-cap companies are also
more likely to go bankrupt. For these reasons, small-cap stocks are generally
considered riskier than large-cap stocks.
With all these risks involved in investing, why invest?
The answer lies in the concept of risk premium, which is our next