Risks associated with financial markets include uncertainty, volatility, default risk, counterparty risk and interest rate risk. Different asset classes have different types of risk.
Volatility is a major risk for all markets. Volatility is the uncertainty in the change of an asset’s value. There are statistical measures that can define the historical volatility for an asset. A higher level of volatility indicates larger moves and a wider change in the asset's value. Volatility is a non-directional value. A higher volatility asset has as good a likelihood of making a larger move up as it does down, which means they have a larger impact on the value of a portfolio. Some investors like volatility, while others try to avoid it as much as possible. (For related reading, see "Understanding Volatility Measurements.")
Counterparty risk is part of the derivatives swap market. Counterparty risk is the risk one party in a credit swap may default on an agreement. Credit swaps are the exchange of cash flows between two parties and are based on changes in the underlying interest rates. Counterparty defaults on swap agreements were one of the main causes of the 2008 financial crisis.
Default Risk and Interest Rate Risk
Default risk is found in the bond and fixed income markets. It is the risk that a borrower may default on its loan obligations and not pay the lender outstanding amounts. Generally, a higher possibility of default results in a larger amount of interest paid on a bond. Thus, there is a risk/reward trade-off investors must consider.
Interest rate risk is another risk in the bond market wherein the price of bonds decrease with a rise in interest rates. (For related reading, see "Managing Interest Rate Risk.")