Glossary: 20 types of risk you should know about

1. Interest rate risk

The risk of an asset losing its value due to the changes in the interest rate is known as the interest rate risk. Interest rate risk is generally associated with debt instruments such as bonds.

2. Price risk

Price risk is basically the risk of the price of an asset - such as shares, commodities, or bonds - declining in the future due to a change in the interest rates.

3. Reinvestment risk

Investments often give out interest or dividend payouts. The risk of not being able to reinvest interest or dividend payments at the same rate of return as the original investment is termed as reinvestment risk. 

4. Market risk

Market risk is essentially the risk of an asset losing its value due to the fluctuations in its price. 

5. Absolute risk

Absolute risk can be defined as the probability of a stated event happening. In the case of an investment, you can consider it as the risk of making a loss on an investment. 

6. Relative risk

When you compare the probability of a stated event happening for two different assets, you get relative risk. 

7. Directional risk

The risk of an asset moving against the direction that you want it to move is termed as directional risk. 

8. Non-directional risk

If you do not consistently follow a particular method of trading, that kind of strategy comes with its own brand of risk. This is known as non-directional risk. 

9. Basis risk

A hedged position may not always be perfectly matched. There may be slight fluctuations or differences between the two positions, which can still end up causing small losses to a trader. The risk that you take on as a result of imperfect hedging is termed as basis risk. 

10. Volatility risk

The risk of an investment losing its value due to the volatility of its price is termed as volatility risk. 

11. Inflation risk

Inflation risk can be summed up as the risk of your investments losing their value over time due to the effects of rising inflation. This risk primarily affects debt and money market instruments, and it doesn’t particularly apply to stock investments.

12. Liquidity risk

If an asset cannot be bought or sold freely as and when possible, it is said to be illiquid. And the risk of an asset being illiquid is known as liquidity risk. 

13. Financial risk

Financial risk is the risk of your investments losing their value due to the changes in certain factors. The changes in these factors do not usually have a market-wide impact, although their effects can sometimes extend to multiple industries or companies. 

14. Exchange rate risk

The risk of your investments losing their value due to exchange rate fluctuations is termed as exchange rate risk. This risk needs to be accounted for when you invest in securities outside of your home country. 

15. Recovery rate risk

The risk of not being able to recover a debt or a loan that you’ve given is known as recovery rate risk. As with funding liquidity risk, this risk primarily affects companies that are in the practice of lending to other entities. 

16. Sovereign risk

The risk of a government not being able to meet its debt or loan obligations is termed as sovereign risk. Sovereign risk primarily affects instruments issued by the government such as T-bills, G-Secs, and gilt-edged funds, among others. Generally sovereign risk is considered to be zero. 

17. Settlement risk

In a market trade, the risk of default by a counterparty is generally known as settlement risk. In this day and age of electronic trading, settlement risks have been mitigated to a very large extent, thanks to robust risk management systems from both stock brokers and stock exchanges. That said, the risk still exists; maybe not as much for equity delivery trades, but for derivative trades, settlement risk is sometimes an issue.

18. Operational risk

Operational risk is the risk of the business operations of a company being disrupted due to a certain set of factors. The disruption in business operations almost always leads to losses or at the very least lower the value of your investments. 

19. Legal risk

The risk of losses arising from a company being non-compliant with the legislations, laws, or governmental policies applicable to it is termed as legal risk. It is sometimes also referred to by traders as regulatory risk.

20. Political risk

Political risk is the risk of losing the value of your investments due to changes in policies set by the government. Governmental policies may sometimes negatively impact some businesses. Some policies may also be unfavourable to an industry. In such situations, your investments may end up losing their value or may even go into severe losses.