what is risk 
risk is defined in financial terms as the chance that an outcome or investment s actual gains will differ from an expected outcome or return risk includes the possibility of losing some or all of an original investment 1quantifiably risk is usually assessed by considering historical behaviors and outcomes in finance standard deviation is a common metric associated with risk standard deviation provides a measure of the volatility of asset prices in comparison to their historical averages in a given time frame overall it is possible and prudent to manage investing risks by understanding the basics of risk and how it is measured learning the risks that can apply to different scenarios and some of the ways to manage them holistically will help all types of investors and business managers to avoid unnecessary and costly losses the basics of riskeveryone is exposed to some type of risk every day whether it s from driving walking down the street investing capital planning or something else an investor s personality lifestyle and age are some of the top factors to consider for individual investment management and risk purposes each investor has a unique risk profile that determines their willingness and ability to withstand risk in general as investment risks rise investors expect higher returns to compensate for taking those risks 2a fundamental idea in finance is the relationship between risk and return the greater the amount of risk an investor is willing to take the greater the potential return risks can come in various ways and investors need to be compensated for taking on additional risk for example a u s treasury bond is considered one of the safest investments and when compared to a corporate bond provides a lower rate of return a corporation is much more likely to go bankrupt than the u s government because the default risk of investing in a corporate bond is higher investors are offered a higher rate of return 3quantifiably the risk is usually assessed by considering historical behaviors and outcomes in finance standard deviation is a common metric associated with risk standard deviation provides a measure of the volatility of a value in comparison to its historical average a high standard deviation indicates a lot of value volatility and therefore a high degree of risk individuals financial advisors and companies can all develop risk management strategies to help manage risks associated with their investments and business activities academically there are several theories metrics and strategies that have been identified to measure analyze and manage risks some of these include standard deviation beta value at risk var and the capital asset pricing model capm measuring and quantifying risk often allow investors traders and business managers to hedge some risks away by using various strategies including diversification and derivative positions riskless securitieswhile it is true that no investment is fully free of all possible risks certain securities have so little practical risk that they are considered risk free or riskless riskless securities often form a baseline for analyzing and measuring risk these types of investments offer an expected rate of return with very little or no risk oftentimes all types of investors will look to these securities for preserving emergency savings or for holding assets that need to be immediately accessible examples of riskless investments and securities include certificates of deposits cds government money market accounts and u s treasury bills the 30 day u s treasury bill is generally viewed as the baseline risk free security for financial modeling it is backed by the full faith and credit of the u s government and given its relatively short maturity date has minimal interest rate exposure 456while savings accounts and cds are riskless in the sense that their value cannot go down bank failures can result in losses the fdic only insures up to 250 000 per depositor per bank so any amount above that limit is exposed to the risk of bank failure while u s government bonds are often cited as riskless investors can lose money if the government defaults on its debt the u s came close to defaulting on its debt in 2011 when a political standoff over the debt ceiling led to a downgrade of its credit rating by standard poor s the episode caused significant volatility and uncertainty in financial markets and reduced economic growth 7a looming default in 2023 would likely be worse given the higher level of overall debt and the more polarized political environment 8risk and time horizonstime horizon and liquidity of investments is often a key factor influencing risk assessment and risk management if an investor needs funds to be immediately accessible they are less likely to invest in high risk investments or investments that cannot be immediately liquidated and more likely to place their money in riskless securities time horizons will also be an important factor for individual investment portfolios younger investors with longer time horizons to retirement may be willing to invest in higher risk investments with higher potential returns older investors would have a different risk tolerance since they will need funds to be more readily available 9types of financial riskevery saving and investment action involves different risks and returns in general financial theory classifies investment risks affecting asset values into two categories systematic risk and unsystematic risk broadly speaking investors are exposed to both systematic and unsystematic risks systematic risks also known as market risks are risks that can affect an entire economic market overall or a large percentage of the total market market risk is the risk of losing investments due to factors such as political risk and macroeconomic risk that affect the performance of the overall market market risk cannot be easily mitigated through portfolio diversification other common types of systematic risk can include interest rate risk inflation risk currency risk liquidity risk country risk and sociopolitical risk 10unsystematic risk also known as specific risk or idiosyncratic risk is a category of risk that only affects an industry or a particular company unsystematic risk is the risk of losing an investment due to company or industry specific hazard examples include a change in management a product recall a regulatory change that could drive down company sales and a new competitor in the marketplace with the potential to take away market share from a company 10 investors often use diversification to manage unsystematic risk by investing in a variety of assets 1in addition to the broad systematic and unsystematic risks there are several specific types of risk including business risk refers to the basic viability of a business the question of whether a company will be able to make sufficient sales and generate sufficient revenues to cover its operational expenses and turn a profit while financial risk is concerned with the costs of financing business risk is concerned with all the other expenses a business must cover to remain operational and functioning 10 these expenses include salaries production costs facility rent office and administrative expenses the level of a company s business risk is influenced by factors such as the cost of goods profit margins competition and the overall level of demand for the products or services that it sells operational risk is a type of business risk that arises from the day to day operation of a business and can include risks associated with system failures human errors fraud or other internal processes that might negatively impact a business s financial performance operational risks can be managed through effective internal controls processes and systems businesses and investments can also be exposed to legal risks stemming from changes in laws regulations or legal disputes legal and regulatory risks can be managed through compliance programs monitoring changes in regulations and seeking legal advice as needed credit risk is the risk that a borrower will be unable to pay the contractual interest or principal on its debt obligations 10 this type of risk is particularly concerning to investors who hold bonds in their portfolios government bonds especially those issued by the federal government have the least amount of default risk and as such the lowest returns corporate bonds on the other hand tend to have the highest amount of default risk but also higher interest rates bonds with a lower chance of default are considered investment grade while bonds with higher chances are considered high yield or junk bonds investors can use bond rating agencies such as standard and poor s fitch and moody s to determine which bonds are investment grade and which are junk 3country risk refers to the risk that a country won t be able to honor its financial commitments 10 when a country defaults on its obligations it can harm the performance of all other financial instruments in that country as well as other countries it has relations with country risk applies to stocks bonds mutual funds options and futures that are issued within a particular country this type of risk is most often seen in emerging markets or countries that have a severe deficit 