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There are broadly two kinds of risks associated with investing in equity: Systemic risks & Non-systemic risks
Systemic risk
This implies ‘risk in the system’. This risk applies to the entire market and includes risks such as interest rate risk, inflation risk, exchange rate risk, political risk, etc. Some of the important systemic risks are indicated below:
Interest rate risk. Interest rate risk can affect the overall market. Interest is the cost of borrowing money. As interest rates rise, money become more expensive to borrow, and companies that have lined up expansion plans may postpone their plans due to the high interest cost they have to bear. Moreover, for consumers high interest rates can alter their plans for purchasing a home or car due to high monthly installments. This results in lower consumption and reduced economic activity.
Inflation risk. Inflation risk can influence all asset classes. Inflation is nothing but the steady increase in prices of goods and services. With rising inflation, manufacturers of goods incur higher raw material costs and see profit declines. Such a risk is detrimental to the stock market and the overall economy.
Exchange rate risk. Exchange rate risk is the risk of an investment’s value changing due to changes in currency exchange rates. This risk usually affects businesses that export and/or import but can also affect the overall economy. For example, if the rupee depreciates against the dollar then Indian exporters will benefit since they will be able to get more rupees for every dollar. An appreciating rupee against the dollar has the opposite effect.
However, a continuously falling currency does not always augur well for our capital markets. FIIs are one of the main investors in our capital markets. If our currency continuously depreciates, it will result in lower investment values when FII sell their holdings and convert the sale proceeds back into the original currency.
Political risk. Political risk implies political instability, which can affect the general economy. A stable and progressive government can influence the investment climate in a country and have an affect on the overall market. Further, war, riots, etc. will have a similar affect on the economy.
Non-systematic RiskThis is risk that is very specific to a particular stock or an industry. Some of the important non-systemic risks are indicated below:
Industry Risk. Industry risk implies risk that directly impacts a sector or industry. For example, the tobacco industry is penalised with high duties due to the adverse health factors associated with this sector.
Risk of employee Strike. Employee agitations result in stoppage of production, which, in turn, results in lower profitability of the company.
Technology risk. This risk is applicable to a company that does not adapt to new technology, which could significantly improve its business functioning and prospects.
Coping with Risks
While systemic risks are not in one’s control, non-systemic risks can be assessed for each company before one makes an investment decision.
Source: Minterest
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