Investment Risks: Definition & Types

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  • 0:03 Investment Risk
  • 0:25 Types of Investment Risk
  • 3:57 Lesson Summary
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Lesson Transcript
Instructor: Noel Ransom

Noel has taught college Accounting and a host of other related topics and has a dual Master's Degree in Accounting/Finance. She is currently working on her Doctoral Degree.

This lesson highlights the definition of investment risk and the differences between the various types of investment risks investors face in the marketplace.

Investment Risk

The concept of investment risk describes the likelihood of potential losses when you're making an investment. Risk is the general likelihood of losing the original investment, and investments are exposed to various types of risks throughout the lifecycle of the investment. Some of the most common types of investment risks are market risk, liquidity risk, credit risk, and inflation risk.

Types of Investment Risk

Monty earns a bonus every year from his employer. This year, Monty saved enough to start an investment account. He opens a brokerage account and deposits his savings into the account. Now Monty needs to decide which investments to select, so he gets the help of an advisor. Monty makes the necessary investment choices and makes additional deposits into the investment account as he earns more money.

The investments Monty makes in his account are vulnerable to different types of investment risk. This means that there is a chance that Monty's investment account may lose value, depending on the various risks he encounters. Let's learn what types of risk Monty may face.

Monty's account is subject to market risk, which means there is a risk the value in Monty's account will decrease because of circumstances that happen in the economy. For example, equity risk refers to investments in specific shares of stock or mutual funds. A stock is a form of capital a company raises by issuing shares of ownership in their company. A mutual fund is a pool or collection of various stocks. The market price or value of stocks or mutual funds can vary from day to day, and there is a chance the value of the shares will decline.

Interest rate risk is another type of market risk that refers to the risk of losing value in an account due to fluctuations of the interest rate, or prime interest rate. The prime interest rate is the lending rate used by the United States to set benchmarks for rates on loans, investment earnings, and investment purchases. Interest rate risk applies to bond purchases or bond mutual fund purchases.

Bonds are very sensitive to interest rate risk. For example, as the interest rate increases, the value of existing bonds decrease, and vice versa. Another type of market risk is currency risk, which refers to investments in foreign stocks or bonds. As exchange rates fluctuate, there may be a risk of losing money due to these daily movements.

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