Risk is everywhere. In the world of investing, most types of risk have been categorized and defined.
As an investor, it pays not only to know about the various types of risk, but also to understand how each one affects your investments.
If your investments involve companies that do business in various parts of the world, called multinationals, you need to be aware of risks that come from dealing in global markets.
Market risk is anything that affects an entire market.– not just one stock or even a segment. The level of market risk rises for those who invest in companies that are global in nature because there are more markets in play.
Another term for market risk is systemic risk. One important thing to know is that diversification – holding a broad portfolio of securities – will not provide protection against systemic risk.
Any event that could potentially affect most or all of the stock market is a market or systemic risk. This includes huge natural disasters, a recession, widespread political turmoil or even a terrorist attack.
The market downturn in 2007 that began in the United States that caused a worldwide recession is the most recent example of a large-scale systemic event. Other than exiting the market, there was little anybody could do to guard against it.
Political changes or instability in a country or region can result in geopolitical risk.
This can range from a change of leadership, a takeover by the military, or a new law that impacts financial markets. It can also involve a major change in the way people interact with their government or with each other.
One trait of geopolitical risk is that its effects are difficult to predict. Political upheaval in one country could cause a market meltdown. In another, the effect might be considerably less.
In addition, intervention by other countries or international agencies like the United Nations can mitigate or reduce the impact of political turmoil and with it, geopolitical risk.
The worst outcome of geopolitical risk would be the inability to withdraw capital from an investment or even the loss of that entire investment due to a government takeover or other factors.
Examples of geopolitical risk abound. Current sanctions against Russia by a host of nations; ISIL’s takeover of vast regions of the middle east; Boko Haram’s kidnapping of children in Nigeria and subsequent world outrage to name just a few.
With so many public companies having a global presence, it’s almost impossible to avoid the possibility of geopolitical risk. Paying attention to the news and knowing where in the world companies in which you have invested operate is the best way to stay on top of this risk factor. A diversified portfolio can provide protection as well.
Currency risk enters the picture when you own stock in a company that has assets or does business in countries with different forms of currency.
In addition to changes in the price of the company’s stock, there is the change in the value of each country’s currency with which you must contend.
Although geopolitical risk factors can affect the currency of a given country, lack of political upheaval does not mean currencies will not fluctuate.
Hedging positions is one way of mitigating or protecting against fluctuations in currency exchange rates.
One way to do that is to own various foreign securities in order to diversify your portfolio.
Another involves hedging with currency futures to protect against currency fluctuations.
Finally, investing in a variety of currencies through the foreign exchange market (Forex) is an additional way of taking advantage of fluctuations in currency valuations worldwide.