Investment Risk

Introduction

It costs money to make money and that is where investments come in. Investment is the capital

invested in a business venture with the prospect of earning a percentage of profit on the principal

amount. A risk is an unavoidable factor when it comes to making an investment of any sort as the

future is unpredictable in this everchanging business environment. Generally, high risk is

associated with high gain but in most cases, investors take on calculated risk to make sure their

capital is safe. This is a portfolio describing several relevant concepts of investment risks to help

acknowledge the association of investment criteria in financial sectors of business and possible

risks occurrence. A detailed summary of the issue, as well as a case study, is presented with due

discussion over the subject matter. There will also be a descriptive analysis of various kinds of

investment that may be experienced throughout my financial profession or I might come across

during the course of implementation of the business plan.

Summary

Investment is defined as the distribution of money for certain business operation in the promise of

the future return of it with added profit to it. Risk, on the other hand, results from an unforeseen

situation that causes something of value. In financial terms, financial risk is defined as the possible

occurrence of a situation where the expected return on investment may not be achieved (Baker,

2015). When conducting the business operation, financial organizations expect to acquire profit

from invested resources as much as possible. But, the risk is undeniable as the future holds possible

environmental scenario that causes a shift in the factors contributing to acquiring of the return and

as profit earning is stopped or slowed down, achievement of expected return on investment within

the expected time frame is threatened.

Hence, Investment risk refers to the possibility of a downturn or unexplained and unpredicted

occurrence of loss when an investment has been made and a possible return or investment is

expected (Kiernan, 2018). In broad discussion, investment risk is the possible occurrence of loss

scenario when the investment is made on the possibility to acquire profit or return, but instead

there is an uncertain chance form future that suggests that the possible return can be omitted in

unpredicted situation and as a result the investment or a portion of it made will be lost with possible

consequences.

Therefore, to be successful in operating professionally in the financial field, it is necessary to

understand possible risk factors for investments. In the broad financial term, there are various types

of risk that can occur during different business operation. One aspect is the business risks that

refers to the possible uncertain situation affecting business operation in the organizations. These

usually are very close to the business organization and can be regulated or overcome by little

strategizing or funding. On the other hand, market risks are associated with all the functional
aspects of the economic market in which the business operates (Bodie, 2017). This kind of

investment risks usually is similar for all organization. The business organizations facing such

risks need to keep their calm in handling such situations and also needs to conduct a regular

appraisal of the market situations to stay top of the change in order to take the earliest action to

leverage or avoid the situation.

It is also necessary to understand the risk induced effects in the management of the business

organization. While incurring risks can be devastating in case of earning less profit from

investment than expected as promised, it can affect various important operation such as asset and

resource allocation for organizational functioning, diversification of investment from organization

leading to better ROI and so on. This discussion will also discuss hedging which is supposed to be

a risk management technique for financial organizations were a possible risk and their effect are

mitigated to be favorable for the business and safeguard the actual investment.
Literature Review

Making an investment in various projects is day to day necessity for business organizations. The

investments are made in situations that are dynamic and have the ability to incur much return over

made investment. However, in general, term risk refers to uncertainty both positive or negative,

financial or investment risks are mainly loss of return on investment (ROI) and hence, negative

consequences resulting in fall of profit or return prospect over already made investment.

Investment risk

Risk upon investment is the uncertain situation causing a shift in actually earned return from

investment as compared to expected return as calculatedly predicted beforehand. However, in the

broad financial term, the risk is mostly associated with negative return or lack of return from the

investment. U.S. Securities and Exchange Commission (2019) also defined risk in this term as they

describe financial or investment risk as a potential loss in investment decisions. This definition is

in support of David (1997) definition of risk where he described this investment bound risk as the

fall of value for firms as a result of changing business environment.

Type of investment risk

Horcher (2006) described that there is a total of six kinds of risks in financial investment. These

are- credit risk, counterparty settlement risk, legal risk, sovereign risk, and concentration risk.

However, Hennie (2003) also classified risk and said that there are various categories that

investment risk can be divided into including credit risk, sovereign risk, and corporate or legal

risk. In a similar manner, the risk of financial investment in the modern business environment can

be typecast into interest risk, inflation risk, volatility risk, etc. According to the U.S. Securities and

Exchange Commission (2019) as well.

Considerations for investment risks

Chong (2013) declares risk as having tow different consequences in organizations. Firstly, he

believes that neglecting risks in business investment can seriously harm the investor in terms of

less or no return on their investment. Secondly, overestimation of risk impeded the growth of

organization and business process since such kind of risk actually can be helpful in growth beyond

steady profit earning which suggests that in any circumstance risk is part of the investment plan.

His highly mathematical discussion discusses different regulatory guidelines to manage risks by

conducting risks management for business investment.

Managing risks

Managing uncertain situations is not possible, yet managing risk can be opted by analyzing for

possible risk and planning accordingly to mitigate it sooner through organizational operations.

Mishra and Mishra’s (2014) discussion in their literature review article also suggests that risk

assessment has been granted as a possible beneficial means for increasing risk tolerance or

otherwise mitigating investment risk. On the other hand, Shri M. Narasimham (1998) on his report

to a committee of banking sector reform in India discusses that prudent management system and

technological implementations for synthesizing form various data acquired from the business

performance can be helpful in lessening risk over investment matters. This, however, can be

aligned with Mishra’s modern analysis of risk management as this is a part of organizational

management and therefore evidence of prudent management system. So, management of risk can

be done by allotting assets elsewhere, diversifying investment context as well as opting for

hedging, etc.
Case Study

I have been planning to invest in a coffee shop in my locality. When planning for the business, I

have found that there is a lot of demand for quality snacks and coffee service in my locality and as

a result people here feel the need for coffee shop very much. As the need is pretty intense and

possible profit earning is favorably good, my initial plan is to invest in the acquisition of pace for

operation of the coffee shop, furnishing the shop and acquiring rights for the businesses well as

ensuring that all required utilities are taken permission for.

Therefore, the first step to financial planning is an investment decision. But, for that, an investment

capable of handling acquisition of all other resources must be made. To do that, I will need to plan

for the initial costs as well as regular operating cost in the business to make an assumption of the

need for investment amount. This can be done through market analysis over all relevant aspects of

the business and associating these with respective pricing and cost ranges. After the discussion

helps me calculate the amount that will be needed, I will have to plan for getting all of this

investment in a liquid asset or fixed asset from where relevant to be utilized properly. Also, I will

be planning for break-even point to be fulfilled by the third year of operation.

To acquire these investments, I can invest my own savings, ask others such as my friends and

relatives to partner up with me or request a loan from the bank on monthly repayment promise.

The bank loan acquiring will be directed by several documents provided to them and promising

securities in exchange for the loan in most case.

Now, according to my concept over investment risks, there is supposed to be several factors that

can create negative impact over my profit earning and hence lessens the expected Return on

Investment (ROI) from the business. Therefore, I will need to follow a risk management plan

whenever necessary. However, since it is in the beginning, I will have to assess all possible risks
such as possible competition emerging, a potential customer’s changing their preference for the

coffee shop, other recreational facilities providing them with their needs, etc. So, depending on

these, I will have to plan accordingly to allocate my resources where they can be best reversible

into liquid money, plan for securities such as insurance and create a threshold for business success

or Break-even point to plan on bankruptcy in any case.

Terms associated with business risks

II. What is Investment Risk?

A. Investment risk: Investment risk refers to the possibility of risks or uncertainties which are

accompanied by any kind of investment. These kinds of risks are generally related to losses.

B. Averages and Volatility: Averages and volatility is the amount of return which is measured

and expected to be obtained from a specific amount of security. The risks related to a security

increases with the increase of its volatility (Chong, 2017). I will have to plan for this volatility to

make sure it does not occur after two weeks of initial operation and remain steady until break-even

point s reached in three years.

III. Types of Investment Risk

A. Business Risks

1. Management Risk

a. Defining Management Risk: The term management risk refers to the amount of risk or

uncertainties which is obtained because of the poor or inefficient kind of management in a certain

business organization (Mishra, 2014).

b. Examples of Management Risk: Risk can be managed by a number of ways. Some of which

are-

 Avoidance of the risk: Risks can always be avoided and if they could be, then there will be no

risk to be managed. Sometimes it is positive to not take some certain risks and to avoid those.

 Uses of information technology: The modern world is blessed with a lot of gifts of modern

technology and many of those can assess if a certain investment will be accompanied with risks

and can also find out the amounts of that risks. This is a very effective way of risk management.
 Mitigation of risk: Mitigation of risk is another example of managing risk and there are certain

ways for doing that as well.

 Accepting the risk: Acceptance of the risk is one of the most common ways to deal with and

manage the risks accompanied with the investment. Not all risks can be avoided and while

doing business activities, risks are inseparable. That is why; accepting the risks for what they

are and possessing the ability to still find out some ways in making a profit from that risky

investment is the greatest challenge.

To avoid management risk in my coffee shop, I will be implementing better organization of task

and use IT support for attracting customers and being timely relevant.

2. Credit Risk

a. Defining Credit Risk: The credit risk is that kind of risk which a lender of some amount of

money has to encounter if the borrower is less likely to pay the money which has been lent. For

example, if I fail to pay the bank on my loan payment, it will be a credit risk for the bank.

b. Examples of Credit Risk: Some of the examples of credit risk are- a sudden rise in the rate of

interests, decreasing of the cash flow from the operations of the business, sudden huge changes in

the nature of the market and so on.

B. Market Risks

1. Liquidity Risk

a. Defining Liquidity Risk: The term liquidity risk generally denotes to the ability of something

which has been invested to be bought or sold in the market after a certain period of time.

b. Examples of Liquidity Risk: Some notable examples of liquidity risk are- securities which

have the marketability, credit lines, and terms of debts and so on.
2. Reinvestment Risk

a. Defining Reinvestment Risk: The risk of reinvestment is usually the kind of risk which

indicates the possibility of earning a decreased amount of money if the investor opens up new

security (Bodie, 2017).

3. Inflation Risk

a. Defining Inflation Risk: The inflation is that kind of risk in investment which indicates if there

are possibilities of not getting the cash flows as returns due to the changes in the purchasing power

of the people which has happened due to inflation. Based on the definition, this risk is also known

as the inflation risk.

b. Examples of Inflation Risk: If the inflation rate increases, the purchasing power of the people

of a country will decrease which will lead to the losses of the investment. This is an example of

inflation risk. My customer of the business will be affected by inflation very much and so I will

have to plan for and adjust prices to sustain the operation.

4. Foreign Investment Risk:

a. Defining Foreign Investment Risk: The foreign investment risk denotes to the uncertainties in

an investment which happens due to the continuous fluctuations in the foreign exchange rates of

the economy (Kiernan, 2018). This kind of risk is also known as or is related to currency risks.

b. Examples of Foreign Investment risk: If such happens that investment is denominated in the

value of foreign currency, then due to the ups and downs of any kind in the rate of foreign exchange

in the market will hugely impact on the condition of that investment. This is a pure example of

foreign investment risk.

5. Credit Risk

a. Defining Credit Risk: The credit risk happens due to the failure of different stakeholders of the

market to repay for the money which has been lent is known as the credit risk as well.

b. Examples of Credit Risk: Sometimes the investor suffers from a certain amount of loss due to

the inability of the stakeholder of the market to pay the amount of money and the investor being

the lender of the money faces losses and also sometimes becomes unable to carry on with the

regular investment activities. This kind of risk is the example of credit risk.

6. Regulatory Risk

a. Defining Regulatory Risk: A regulatory risk is that kind of risk which is observed when the

regulations, laws or legislation of a country impact or influence the securities of any company or

industry of any kind by any way (Lam, 2014).

b. Examples of Regulatory Risk: Some examples of regulatory risk are- tax policies of the

government, tariffs, Minimum amount of wages, policies regarding leaves and others. I will have

to stay mentally prepared for any possible regulatory risk and invest accordingly so that this

unpredictable change cannot incur too much loss for my business.

IV. Managing Risk

A. Asset Allocation

1. Defining Asset Allocation: The meaning of the term asset allocation refers to the process by

which the assets of a person are distributed into a number of categories.

2. Examples of Asset Allocation: The categories of asset allocation can be termed as the examples

of the process which can be bonds, mutual bonds, stocks and so on.
B. Diversification

1. Defining Diversification: Diversification bears a special meaning in finance. It is the fact when

the investor distributes his amount of capital into a number of factors instead of investing the whole

amount into one single asset. The investment in a different variety of assets reduces the number of

risks by a great deal.

2. Examples of Diversification: If the investor invests all his money into different companies

rather than spending them all for one, it would be an example of diversification.

C. Hedging

1. Defining Hedging: Hedging is that kind of position of investment which is done in order to

restrain any kind of loss to happen due to the investment (Chong, 2017).

2. Examples of Hedging: One perfect example of hedging is the insurance of housing. After it is

done, if the house catches fire or is damaged due to any reason, the investor will not face any kind

of losses.

In my business investment scenario, I will have to use my knowledge over market risks and keep

track of any possible changes so that adequate measures can be taken. Also, making understanding

of the different risk management technique will be helpful such as the issuance of insurance over

fire safety and such for the business will help mitigate any uncertain accidental costs.
Conclusion

The paper provides detailed information about elements associated with investment and risk. the

portfolio contains information about risks associated with investments in a coffee shop and the

steps that can be taken to ensure the safety of the capital invested. From my understandings from

the findings here, it has been proven that risks are part of the investment plan and there is a need

for deep knowledge to overcome risk and control of ROI. Attempts have been made to take steps

that can help reduce risk in the case study. The paper also contains examples of factors that make

up the investment scenario.

References

Baker, H. K., CFA and Filbeck, G. (2015). Investment Risk Management (a review). Investment

Risk Management 2016, Volume 11 Issue 1.

Bodie, Z., Kane, A., Marcus, A.J. (2017). Investments (11th ed.). New York: McGraw-Hill.

FINRA Staff. (2018). Investment Risk, Explained. The Motley Fool. Retrieved from:

https://www.fool.com/investing/2018/05/11/investment-risk-explained.aspx

Chong, Y. Y. (2013). Investment Risk Management: Investing under Risk. 21-40.

doi:10.1002/9781118673324.ch3

Investment Risk Management: An Overview. (2015). Investment Risk Management, 3-16.

doi:10.1093/acprof:oso/9780199331963.003.0001

Chong, Y. Y. (2013). Investment Risk Management: Introduction to Investment Risk, 1-4.

doi:10.1002/9781118673324.ch1

Mishra, S., & Mishra, M. (2014). Financial Risk Tolerance: A Literature Review. Siddhant- A

Journal of Decision Making, 14(1), 10. doi:10.5958/j.2231-0657.14.1.002

Investopedia Staff. (2019). Risk and Diversification: Different Types of Risk. Investopedia.

Retrieved from: https://www.investopedia.com/university/risk/risk2.asp

Kiernan, K. (2018). Investment Risk, Explained. FINRA. Retrieved from:

https://www.finra.org/investors/highlights/investment-risk-explained

Lam, J. (2014). Enterprise Risk Management from Incentives to Controls. Wiley; 2 edition. ISBN

978-1118413616.
U.S. Securities and Exchange Commission. (2019). What is Risk? Investor.gov. Retrieved from:

https://www.investor.gov/introduction-investing/basics/what-risk