Risk Categories

There are 2 basic risk categories: systematic risk and unsystematic risk.

Systematic risk is usually a general event or phenomenon which can affect many of your portfolio’s investments. An important political happening can affect the whole market including several of your assets. The individual investor cannot do anything to protect himself against this kind of risk.

Unsystematic risk is also called “specific risk” and influences only a very small number of investments. An example might be an explosion at a company’s plant. This would only affect the specific stock. The way to guard oneself from unsystematic risk is to diversify one’s investments.

Working with the above types of risks, there are various types of risk involved.

Credit Risk (also known as Default risk) – This is the risk that an individual or company might not be able to repay its debts or the interest due on those debts. Credit risk is especially prevalent for those investing in bonds. Generally, corporate bonds are higher risk and offer higher rewards, in the form of higher interest rates. Bonds which are unlikely to default are considered “investment grade” bonds. Bonds with greater chances of default are known as “junk bonds.” There are rating services such as Standard & Poors which rate the risk factors of various bonds.

In our next article we will discuss other types of risks.