HOW INVESTMENT RISKS INTERACT?

It is challenging enough that investors must concern themselves with identifying all of the individual risks applicable to the tremendous variety of investments available for purchase. A second and equally aspect of risk analysis is how risks frequently interact with one another and how the interaction affects rates of return. Some types of risk tend to operate independently of other risks, so that analyzing the effect of the uncertainties on an investment’s rate of return is a relatively straightforward matter. For example, liquidity risk is an uncertainty unique even to different investments of the same general type. Many issues of bonds subject investors to significant amounts of liquidity risk, while other bonds can be sold quite easily. Other risks act in concert to affect the rates of return acting together frequently produces a different result than would be expected on the basis of a single risk. If the risks influence the investment’s return in a similar manner, then the two risks reinforce one another and increase the volatility of the investment’s return.