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Types of investment risks -2

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TYPES OF INVESTMENT RISKS

Liquidity Risk
Liquidity risk refers to the possibility that an investor may not be able to buy or sell an investment as and when desired or in sufficient quantities because opportunities are limited. A good example of liquidity risk is selling real estate. In most cases, it will be difficult to sell a property at any given moment should the need arise, unlike government securities or blue-chip stocks.

Market Risk
Market risk, also called systematic risk, is a risk that will affect all securities in the same manner. In other words, it is caused by some factor that cannot be controlled by diversification. This is an important point to consider when you are recommending mutual funds, which are appealing to investors in large part because they are a quick way to diversify. You must always ask yourself what kind of diversification your client needs.

Reinvestment Risk
In a declining interest rate environment, bondholders who have bonds coming due or being called face the difficult task of investing the proceeds in bond issues with equal or greater interest rates than the redeemed bonds. As a result, they are often forced to purchase securities that do not provide the same level of income, unless they take on more credit or market risk and buy bonds with lower credit ratings. This situation is known as reinvestment risk: it is the risk that falling interest rates will lead to a decline in cash flow from an investment when its principal and interest payments are reinvested at lower rates.

Social/Political / legislative Risk
Risk associated with the possibility of nationalization, unfavorable government action or social changes resulting in a loss of value is called social or political risk. Because the Congress has the power to change laws affecting securities, any ruling that results in adverse consequences is also known as legislative risk.

Currency/Exchange Rate Risk 
Currency or exchange rate risk is a form of risk that arises from the change in price of one currency against another. The constant fluctuations in the foreign currency in which an investment is denominated vis-à-vis one's home currency may add risk to the value of a security.

Investors will need to convert any profits from foreign assets into Naira. If the dollar is strong, the value of a foreign stock or bond purchased on a foreign exchange will decline. This risk is particularly augmented if the currency of one particular country drops significantly and all of one's investments are in that country's foreign assets. If the dollar is weak, however, the value of investor’s foreign assets will rise.

Understandably, currency risk is greater for shorter term investments, which do not have time to level off like longer term foreign investments.

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