As mentioned, Risk is the uncertainty involved in the expected returns. Risk associated with Equities are much higher compared to Debt instruments. So are the returns. This follows the universal principle, “Higher the Risk, Higher the Return”.
The biggest risk associated with Equities is Market Risk. Equity instruments are volatile and prone to price fluctuations on a daily basis due to changes in market conditions.
This is the second biggest risk associated with investment in Equities. Disruption in the internal financial affairs of a company will have a direct impact on the share prices of the company and may cause a loss to the investor. A prime example of such an instance is the Satyam fiasco in the January 2009 or a recent example of management fights in SKS Microfinance.
This refers to the ease with which a security can be sold at or near to its market value.
Securities, which are not quoted on the stock exchanges, are inherently illiquid in nature and carry a larger amount of liquidity risk in comparison to securities that are listed on the exchanges. While securities listed on the stock exchange carry lower liquidity risk, the ability to sell these investments at the market price is limited by the overall trading volume on the stock exchanges.
It is a risk that the counter party does not deliver the security purchased against cash paid for it or value in cash for the security sold is not received after the securities are delivered by us.
Such risk can be avoided by entering into transactions in the nature of delivery versus payment (DVP) or settlements via clearing houses where the Stock Exchange acts as the counter party to every transaction.
The biggest risk associated with investments in foreign securities is fluctuation in foreign exchange rates. If you invest in a US Stock which gives you 20% return over a period of time and the US Dollar depreciates by 10% during this period, your net return in domestic currency will be much lower than 10%.
Other risk involved include restriction on repatriation of capital and earnings under the exchange control regulations and transaction procedures in overseas market.
You will see that a some of the risks listed above also affect Debt Securities. It is very difficult to segregate risks which affect only one type of investment.