Business and Investment Risks: What Every Investor Must Understand
•By Maher Saham
Artikel ini juga tersedia dalam Bahasa Melayu
Loading...
The world of business is one of the broadest sources of income. However, there are times when you can be on top, and times when you can be at the bottom.
For this reason, we cannot only consider profits without looking at the risks involved.
Risk is the uncertainty that comes alongside the returns being offered.
Generally speaking, the higher the risk, the higher the potential return offered to attract investors.
Investments that carry high risk should promise high returns. Otherwise, what incentive do investors have to risk their capital?
The risk associated with an investment is also related to the expected return.
Logically, investors would want higher returns in line with the level of risk they are willing to take.
Therefore, whether you are an entrepreneur or trading in the stock market, you need to be aware of these risks.
Most companies raise funds by issuing shares to investors and borrowing money.
When a company borrows, it becomes burdened with interest and principal payments in the future.
These payments generally have no connection to the company''s profits; rather, they are fixed according to the agreed-upon contract.
Therefore, when business conditions are good and profits are high, shareholders benefit from the borrowing because debt repayments are unaffected and profits are largely distributed to shareholders.
Furthermore, companies that use debt generate higher returns for their shareholders compared to companies that do not use debt.
However, when business conditions deteriorate, the company must still repay its debts even if it is not generating profits.
In this case, debt amplifies the losses borne by shareholders.
So a company that uses debt will experience greater losses compared to a company without debt.
Looking at these two scenarios, we can say that debt increases a company''s business risk.
Companies in any industry are exposed to ups and downs in business risk, but companies that use debt are exposed to even more risk.
This is why debt is referred to as ''leverage''. Greater uncertainty arises when a company borrows, which is called financial risk. The larger the debt used to finance a company, the higher its financial risk.
Interest rate risk particularly affects securities.
Especially securities that offer a fixed rate of return (Fixed Income Securities).
Interest rate risk refers to changes in interest rates that consequently cause a decline in the value of these securities.
Changes in interest rates affect the supply and demand for money.
When interest rates change, many securities prices will fluctuate unpredictably.
Generally, business risk is the uncertainty related to investment income and the ability of an investment to generate returns (interest, dividends) for investors.
For example, a company owner may not profit if the company''s revenue is insufficient to cover employee salaries.
Unexpected changes in prices such as inflation or deflation will affect investment returns in terms of purchasing power risk.
Specifically, this risk involves unexpected price increases (inflation) that reduce purchasing power.
For example, investments offering fixed returns carry high purchasing power risk, and these investments are most profitable during deflation or falling prices.
Liquidity risk is the risk of not being able to sell an investment quickly at a reasonable price.
Many investors may be able to sell their investments by significantly reducing the price.
However, a liquid investment is one where the investor can sell quickly without adversely affecting the investment''s price.
For example, an investment security worth $1,000 would not be considered very liquid even if sold quickly but at a very low price such as $500.
The liquidity of an investment is important to consider.
Generally, investments traded in markets with low transaction volume are less liquid compared to those traded in broader markets.
Assets such as shares and bonds of companies listed on the New York Stock Exchange are typically very liquid compared to others like antique furniture and artwork, which are not as liquid.
Event risk occurs when something happens to a company that has a sudden and significant impact on its financial condition.
It does not necessarily mean the company or market is in poor condition. Rather, it involves unexpected events that have a significant effect and typically directly impact the value of investments.
For example, the death of Micron Technology''s CEO in February 2012.
He was killed in a plane crash. When Micron''s shares opened for trading the following day, they fell by 3.2%.
Event risk can occur in many forms and can affect all types of investments.
Successful investing starts with solid knowledge.
Investment Basics:
Download our free ebook for a comprehensive guide.
Open a CDS Account:
Ready to start? Open a CDS account today.
The main risks include market risk, liquidity risk, event risk, and interest rate risk. Each type of risk requires a different management strategy.
Key methods include portfolio diversification, investing in stocks with high trading volume for good liquidity, and conducting thorough research before investing.
Liquidity risk occurs when investors cannot sell their investment assets at a reasonable price within a reasonable timeframe, especially for stocks with low trading volume.
Understanding risk helps you make wiser decisions, prepare contingency plans, and reduce the likelihood of significant losses that could affect your financial position.
Understanding risk is the first step to becoming a successful investor — the right knowledge helps you make investment decisions with greater confidence.
Open a CDS account today to start investing in stocks on Bursa Malaysia with solid risk management knowledge.
Download our free stock basics ebook to understand how to evaluate risk and return before making investments.
Further reading: