Risks faced by an investor

– Capital Risk

– possibility of loss of some of the original capital :- this is becoz, the value of investments linked to stock market can vary, and although the long term trend tends to be upwards, at any particular time the market might dip so that the investment is worth less than that was originally invested. it may however, be necessary to accept some capital risk to offset other risks.

– Shortfall Risk

– The amount invested in order to reach a financial goal at some time in the future may not reach the target amount. The problem is that if the investor is over cautious, choosing investments with no or low risk, the returns are likely to be lower or could fall short of the amount targeted.

–Interest Risk

– The risk that either the capital value of the income from an investment will change as a result of changes in market interest rates. for e.g the income from a variable rate account can fall or rise which is bad for savers and borrowers. Fixed rates will lock into a return, which is bad for savers but good for borrowers when interest rates rise and vice versa.

– Inflation Risk

-The purchasing power of the investment is reducing

Over time, rising prices reduce the buying power of an investment. This is a main problem where income is being paid out so that the real value of the capital fails. offsetting inflation risk usually means taking on some capital risk

Portfolio Construction Considerations

1. Efficient investors will tend to move their money to those areas where it will achieve the best results. higher returns can be expected if:-
– funds are committed to a particular investment for a longer period
– the risk of capital loss is higher
-larger funds are committed

2. Although there are seperate financial markets in each of the main types of investments (cash deposits, fis, equities), economic and political changes tend to have an impact on all of them, and changes in one can affect another market place. For e.g fall in interest rates could encourage a rise in both FI and equity markets, but lower returns from deposits.

Each investment has a role to play:

1. deposits are good for protection of capital, atleast in nominal terms and over shorter periods, and are a safe haven when times are bad economically.

2. fixed interest securities are good for secure levels of nominal income, with some scop of capital gains if interest rates fall. they are usually less volatile than equities.

3. equities are good for long-term real growth of capital and/or income, although the risk of loss is high than for either fixed interest securities or cash deposits