Risk: Risk is the uncertainty of an outcome, where both positive and negative results are possible. In Border terms there are two types of Risk.

1.      Systematic Risk (Market Risk)

1.       Market risk affecting the entire market.

2.       Uncontrollable, impacts all companies, sectors, and industries.

3.       Influenced by broader economic, political, and financial factors.

4.       Cannot be fully mitigated but can be managed.

2.      Unsystematic Risk

·         Definition: Risk specific to a particular company, industry, or sector.

·         Impact: Unlike systematic risk, it doesn't affect the entire market.

·         Mitigation: Can be managed through diversification.

Types of Systematic Risks and Solutions to mitigate

1.       Interest Rate Risk (Central Bank Responsible)
When interest rates change by the Central Bank of Country, the value of an investment can also change. This is called interest rate risk.

How to Mange Interest Rate Risk

·         Diversification: Spread your investments across different asset classes like stocks, bonds, and real estate.

·         Floating Rate Securities: Consider investing in floating-rate bonds, which adjust their interest rates periodically based on market conditions.

·         Investing in Growth Stocks: Growth stocks, often associated with companies reinvesting earnings for future growth, may be less affected by interest rate changes.

Examples:

ü  Financial Sector: Banks (Increase Positive Impact) & Insurance Companies.

ü  Real Estate: can increase borrowing costs (Increase Negative Impact)

ü  Utility companies:  Like electricity, Gas Water ( Increase Negative Impact)

2.       Inflation Risk

Inflation risk is the risk that the purchasing power of your money will decrease over time. In simpler terms, it means that the same amount of money will buy fewer goods and services in the future.

ü  How is Inflation Measured in India?
The Reserve Bank of India (RBI) is responsible for measuring inflation in India.
One of the primary measures is the Consumer Price Index (CPI). This index tracks the average price of a basket of goods and services consumed by households

To protect your investments from inflation, consider investing in:

1.       Real Estate: Physical property like houses or commercial buildings.

2.       Gold: A traditional safe-haven asset.

3.       Equities: Stocks of companies with strong fundamentals and pricing power.

4.       Commodities: Commodities like oil, gas, or agricultural products.

5.       Inflation-Protected Securities: Securities like TIPS designed to protect against inflation.

3.       Market Risk (Equity Risk)

The risk of losses due to declines in the stock market, driven by macroeconomic factors like recessions or geopolitical issues.
Example: During the COVID-19 pandemic, stock markets globally fell as investor confidence dropped.
To protect your investments from Market Risk

- Diversification Across Asset Classes: Hold a mix of equities, bonds, and cash to reduce the impact of market downturns.
- Hedging: Use options, such as buying put options, to protect against declines.
- Invest in Defensive Sectors: Sectors like healthcare and consumer staples tend to be less affected by broad market declines.

4.       Exchange Rate Risk

The risk of financial loss arising from fluctuations in foreign exchange rates.
Example: A U.S.-based investor in European stocks may see returns affected by changes in the USD/EUR exchange rate.

To protect your investments from Exchange Rate Risk
- Currency-Hedged Investments: Consider hedging currency exposure by using currency-hedged funds or derivatives.
- Invest in Domestic-Focused Companies: Focus on companies with minimal exposure to foreign currencies.
- Diversify Across Currencies: Spread investments across multiple currencies to reduce dependence on one currency.

5. Political and Geopolitical Risk

Risks of financial loss arising from political instability, policy changes, or international tensions that may affect global markets.

Example: Trade tensions between the U.S. and China in 2018 impacted technology companies with global supply chains.

To protect your investments from Exchange Rate Risk
- Global Diversification: Diversify investments across multiple countries to avoid over-reliance on one political climate.
- Invest in Defensive Sectors: Sectors like utilities and consumer staples often perform better during geopolitical instability.

Unsystematic Risk

·         Definition: Risk specific to a particular company, industry, or sector.

·         Impact: Unlike systematic risk, it doesn't affect the entire market.

·         Mitigation: Can be managed through diversification.

Types of Unsystematic Risks and Solutions

1. Business Risk

Description: The risk associated with the individual operations and financial health of a specific company.

Example: If a company loses its market share due to poor management, it may experience declining stock prices.

Solutions:
- Conduct Thorough Research: Analyze company financials, management quality, and industry positioning before investing.
- Invest in Well-Established Companies: Larger companies with stable earnings often carry lower business risk.
- Diversify Across Companies: Reduce exposure to individual companies by spreading investments across multiple stocks.

2. Financial Risk

The risk that a company may fail to meet its financial obligations due to high debt levels or poor financial management.

Example: During the 2008 financial crisis, companies with high leverage, like Lehman Brothers, faced liquidity issues and eventually collapsed.

Solutions:
- Evaluate Debt Ratios: Invest in companies with manageable debt levels and strong cash flow.
- Avoid Highly Leveraged Companies: High debt increases the risk of default, especially in economic downturns.
- Monitor Financial Health Regularly: Continuously assess the companyÂ’s financial statements to stay updated on any signs of financial distress.

3. Liquidity Risk

The risk of not being able to sell an asset quickly without impacting its price. Low trading volumes can make certain stocks illiquid.

Example: Small-cap stocks or shares in private companies often have lower liquidity than blue-chip stocks, making them harder to sell at a desirable price.
Solutions:
- Invest in High-Volume Stocks: Focus on stocks with high trading volume to ensure easier buying/selling.
- Limit Exposure to Illiquid Assets: Avoid allocating a large portion of the portfolio to illiquid investments.
- Plan for Longer Holding Periods: If investing in low-liquidity assets, prepare to hold them longer if necessary.

4. Operational Risk

Description: Risks arising from internal issues within a company, such as technical failures, employee errors, or inadequate processes.

Example: Knight CapitalÂ’s software glitch in 2012 led to a $440 million loss due to a trading algorithm error, eventually forcing the company to seek outside assistance.

Solutions:
- Evaluate Operational Efficiency: Assess companies for strong operational controls and quality management practices.
- Use Reliable Trading Platforms: Choose established brokers with robust security and reliable platforms.
- Conduct Periodic Reviews: Regularly evaluate and adjust investments to limit exposure to companies with potential operational risks.

5. Regulatory and Legal Risk

Description: Risk of financial loss due to changes in laws, regulations, or litigation involving a company or industry.

Example: In 2018, the tobacco industry faced regulatory risks as several countries increased taxes and implemented advertising restrictions on tobacco products.

Solutions:
- Monitor Industry Regulations: Stay updated on regulatory changes that may impact investments.
- Diversify Across Sectors: Avoid concentrating investments in highly regulated sectors to reduce exposure.
- Focus on Companies with Strong Compliance: Invest in companies that are proactive about regulatory compliance.

Comparison of Systematic and Unsystematic Risk

Aspect	Systematic Risk	Unsystematic Risk
Impact	Affects the entire market or economy	Impacts individual companies or sectors
Management	Cannot be eliminated, only minimized	Can be mitigated through diversification
Examples	Inflation, interest rate changes, geopolitical events	Business failure, poor financial management, regulatory issues
Solution Strategies	Diversification across asset classes and hedging	Diversification across stocks and industries