The inverse of investment return is the risk to which an investment is subject. The academic literature has treated the concept of risk extensively. For the purpose of this discussion, risk may be viewed as the likelihood of an adverse outcome (e.g. loss). A critical component of the portfolio management process is the risk management function. Professional and individual investors alike manage risk rather than return. An understanding of the different investments and investment vehicles discussed in the prior chapter would be incomplete without an understanding of the risks that accompany them. This chapter defines the various types of risk and furnishes examples by illustrating the types of investments to which the various types of risk apply.

Learning Objectives

  • Be able to define and discuss the various types of risk to which investments are subject.
  • Be able to define, discuss and differentiate between systematic and unsystematic types of risk.
  • Be able to give specific examples of various types of investment risk.
  • Be able to compare and contrast the various types of investment risk.
  • Be able to discuss why an understanding of investment risk is critical to the portfolio management process.

The Risk Dichotomy

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