Risk is a situation wherein objective probability distribution of the values a variable can take is known, even though the

exact values it would take are not known. The objective probability is one which is supported by rigorous past experience, and the laws of chance. Strictly speaking, while the risk is measurable, uncertainty is not, since a situation of uncertainty can be reduced to a situation of risk by using subjective probabilities, the two terms, risk and uncertainty, are generally used interchangeably

Meaning of Risk

In a practically useful way, the risk can be defined as the chance that the expected or prospective advantage. gain, profit or return may not materialise;that the actual outcome of investment may be less than the expected outcome.

The greater the variability or dispersion in the possible outcomes, or the broader the range of possible outcomes, the greater the risk.
Usually, the variance and standard deviation of return serve as the alternative statistical measures of the risk of the security in an absolute sense. Similarly, covariance measures the risk of the security relative to other securities in a portfolio: the way securities vary with each other affects the overall variance and risk of the portfolio.

Default Risk
Default risk arises from the failure on the part of the borrower or debtor to pay the specified amount of interest and/or to repay the principal, both at the time specified in the debt contract or covenant or indenture. It may be noted that the default risk has the capital risk and income risk as its components, and that it means not only the complete failure to pay but also the delay in payment.

Financial risk is associated with the use of debt financing by firms or companies. Since the presence of debt involves the legal or mandatory obligation to make specified payments at specified time periods, there is a risk that the earnings of the firm may not be sufficient to meet these obligations towards the creditors. In case of shareholders, the financial risk arises because of not only the mandatory nature of debt obligations but also the property of prior payments of these obligations. In short, the use of debt by the firm causes variability of returns for both creditors and shareholders. Financial risk is usually measured by the debt/equity ratio of the firm; the higher this ratio the greater the variability of return and higher the financial risk.

Liquidity risk refers to a situation wherein it may not be possible to dispose off or sell the asset, or it may be possible to do so only at great inconvenience, and cost in terms of money and time. An asset that can be bought and sold quickly, and without significant price concession and transaction cost is said to be liquid. The greater the uncertainty about time element, price concession, and transaction cost, the greater the liquidity risk. Liquidity risk has a different connotation from the point of view of banks and financial institutions. In this context, Liquidity risk refers to their inability to meet the liabilities towards depositors when they want to withdraw their deposits.

Maturity risk arises when the term of maturity of the security happens to be longer.
Since foreseeing, forecasting and envisioning the environment, conditions and situations becomes more and more difficult as we stretch more and more into the future, the long term investment involves risk. The longer the term to maturity, the greater the risk.

Call risk is associated with the corporate bonds which are issued with Call back provision or option whereby the issuer has the right of redeeming the bonds before their maturity.
In case of such bonds, the bond holders face the risk of giving up higher coupon bonds, reinvesting proceeds only at lower interest rates, and incurring the cost and inconvenience of reinvestment

Interest rate risk is the variability in return on security due to changes in the level of market interest rates, or it is the loss of principal of a fixed-return security due to an increase in the general level of interest rates. When interest rates rise, the value or market price of the security drops, and vice versa. The degree of interest rate risk is directly related to the length of time to maturity of the security; if the term to maturity is long, market value of the security may fluctuate widely.

Inflation risk is the risk that the real return on a security may be less than the nominal return. In case of fixed income securities, since payments in terms of rupees are fixed, the value of the payments in real terms declines as the level of commodity prices increases. Inflation risk is also known as purchasing power risk as there is always a chance or possibility that the purchasing power of invested money will decline, or that the real (inflation-adjusted) return will decline due to inflation. It may be noted that inflation risk is really the risk of unanticipated or uncertain inflation. If anticipated, inflation can be compensated. Similarly, inflation risk, like default risk, is more relevant in case of fixed income securities; common stocks are regarded as hedge against inflation. Inflation risk is closely related to interest rate risk since interest rates generally rise when inflation occurs.

Exchange rate risk refers to cash-flow variability experienced by economic units engaged in international transactions or international exchange, on account of uncertain or unexpected changes in exchange rates. Put differently, it is the risk that changes in currency exchange rates may have an unfavorable impact on costs or revenues of, say, business units. There is no exchange rate risk under the fixed exchange rate system, while it is the highest under the freely floating exchange rate system.

Business risk is the uncertainty of income flows that is caused by the nature of a firms business i.e., by doing business in a particular environment. This risk has two components: internal and external. The former results from the operating conditions or operating efficiency of the firm, and it is manageable within or by the firm. The latter is the result of operating conditions which the firm faces but which are beyond its control. Business risk is measured by the distribution of the firms operating income (i.e., firms earnings before interest and tax) over time .

The variability in a securitys total return that is not related to the overall market variability is called unsystematic risk. An investor can build a diversified portfolio and reduce or eliminate this type of risk. Therefore, it has been also defined as that risk which can be reduced or eliminated through diversification of security holdings. The other names for unsystematic risk are non-market risk or diversifiable risk;.

The variability in a securitys total return that is directly associated with the overall movements in the general market or economy is called systematic risk. This type of risk is inescapable no matter how well the portfolio is diversified. It is caused by a wide range of factors exogenous to securities themselves, viz., recession, war, and structural changes in the economy. The other names for systematic risk are market risk or non-diversifiable risk;

Beta indicates the extent to which the risk of a given asset is non-diversifiable; it is a coefficient measuring a securitys relative volatility.
Statistically, beta is the covariance of a securitys return with that of the market for a security class. The security with a higher (than 1) beta is more volatile than the market, and the asset with a lower (than 1) beta would rise or fall more slowly than the market.

Concept of Beta

Security Return

Market Return