Page 77 - DCOM507_STOCK_MARKET_OPERATIONS

Stock Market Operations

Notes Nearly all the losses suffered by investors as a result of default risk are not the result of actual
defaults and/or bankruptcies. Investor losses from default risk generally result from security
prices falling as the financial integrity of a corporation’s weakness – market prices of the troubled
firm’s securities will already have dropped to near zero.

4.1.2 International Risk

All investors who invest internationally in today’s increasingly global investment arena face
the prospect of uncertainty, let us discuss more:
1. Exchange Rate Risk: The returns after investors convert the foreign gains back to their
own currency, there is risk. Unlike the past, when most US investors ignored international
investing alternatives, investors today must recognise and understand exchange rate risk,
which can be defined as the variability in returns on securities caused by currency
fluctuations.
2. Country Risk: Country risk, also referred to as political risk, is a significant risk for
investors today. With more investors investing internationally, both directly and
indirectly, the political and thus economic stability and viability of a country’s economy
need to be considered. The United States has the lowest country risk, and other countries
can be estimated on a relative basis using the United States as a benchmark. Examples of
countries that needed careful monitoring in the 1990s because of country risk included the
former Soviet Union and Yugoslavia, China, Hong Kong, and South Africa.

3. Liquidity Risk: Liquidity risk is the risk linked with the particular secondary market in
which a security trades. An investment that can be bought or sold fast and without
considerable price concession is considered liquid. The more uncertainty about the time
element and the price concession, the greater the liquidity risks. A Treasury bill has little
or no liquidity risk, whereas a small OTC stock may have substantial liquidity risk.
4. Liquid Assets Risk: It is that part of an asset’s total variability of return which results from
price discounts given or sales concessions paid in order to sell the asset without delay.
Perfectly liquid assets are very well marketable and experience no liquidation costs.
Illiquid assets are not readily marketable and suffer no liquidation costs. Either price
discounts must be given or sales commissions must be paid, or the seller must incur both
the costs, in order to find a new investor for an illiquid asset. The more illiquid the asset
is, the larger the price discounts or the commissions that must be paid to dispose of the
assets.
5. Political Risk: It evolves from the exploitation of a politically weak group for the benefit
of a politically strong group, with the hard work of several groups to improve their
relative positions increasing the variability of return from the affected assets. Regardless
of whether the changes that cause political risk are sought by political or by economic
interests, the resulting variability of return is called political risk, if it is accomplished
through legislative, judicial or administrative branches of the government.
6. Industry Risk: An industry may be considered as group of companies that compete with
each other to market a homogeneous product. Industry risk is that portion of an investment’s
total variability of return caused by events that affect the products and firms that make up
an industry. For example, commodity prices going up or down will affect all the commodity
producers, though not equally.

Did u know? Exchange rate risk is sometimes called currency risk.

72 LOVELY PROFESSIONAL UNIVERSITY