Credit Risk (Default Risk)

Credit risk exists when it seems possible that potential borrowers may default on paying back the loans they have obtained from a financial institution for various purposes. A systematic risk will have a negative impact on your assets, and there is little you can do to protect yourself from it because it is so widespread. Conversely, an unsystematic risk will affect only a few of your assets, and you can protect yourself from it by making an effort to diversify your investments.

Note that these risks can be broken down further, especially in regard to stocks and bonds, as follows:

• Credit risk is present when a business or individual may be unable to meet their debt obligations by making scheduled payments on the interest or principal. When purchasing government bonds, the amount of risk is minimal, but the returns are low as well. Generally, with corporate bonds the amount of risk is much greater, but they also have higher interest rates. In addition, "investment grade" bonds are unlikely to default, "junk bonds" carry a greater risk for investors, and they are categorized by Moody's and other investment services.
• The value of your investment can change, especially if you have purchased bonds, because of a fluctuation in interest rates, and political risk exists when it is felt that that the government involved will change its policies on short notice. As a result, emerging nations generally do not invest in foreign markets.
• There is also some risk when a country may be unable to meet its financial obligations. If this happens, it can have a negative impact on the country's futures, options, mutual funds, stocks and bonds-and the effect may even be worldwide since we are now living in a global economy, This often results when a country such as the United States has a severe deficit.
• If you are an international investor, remember that the value of your investment may be affected by currency exchange rates in the future. For example, if your are an American and buy some Canadian stock with Canadian dollars, even if the value of your shares appreciates, you may suffer a loss if the Canadian dollar decreases in value when compared to the American dollar.
• Market risk, the most common and best-known type, is related to the every-day fluctuations in the price of stock, and it applies to options as well. Usually, a stock will perform poorly in a bear market and rally in a bull market, and the volatility investors experience is the effect of certain forces in trading. Since it refers to the activity of an investment, rather than the cause of that activity, volatility is regarded as an indication of risk. Market activity enables people to profit from their investments, and it is essential in order for them to do this. The more unstable the price of a given stock is, the greater the probability is that there will be a dramatic shift in one direction or the other.