Types of Risks

One type of risk is default risk, that is, the risk that the bor­rower will simply not repay the loan, due to either dishonesty or plain inability to do so. Another type of risk, called purchasing-power risk, is the risk that, due to an unexpectedly high inflation rate, the future interest payments, and the principal of the loan when finally repaid, will have less purchasing power than the lender anticipated at the time the loan was made. A similar risk is faced by borrowers. A borrower may cheerfully agree to pay, say, 15 percent interest, expecting that a 12 percent inflation rate will reduce the real value of the loan. But inflation may be only 4 percent.

A third type of risk is called "interest-rate risk" or "market risk", that is, the risk that the market value of a security will fall be­cause interest rates will rise. Suppose that five years ago you bought a ten-year $1,000 bond carrying a 6 percent interest rate, and that the interest rate now obtainable on similar bonds that also have five years to go until they mature is 8 percent. Would anyone pay $1,000 for your bond? Surely not, because they could earn $80 per year by buying a new bond, and only $60 per year by buying your bond. Hence, to sell your bond you would have to reduce its price. But suppose the bond, instead of having five years to matur­ity, would mature in, say, ninety days; what would its price be then? It would still be less than $1,000 since the buyer would get 6 percent instead of 8 percent interest for ninety days; but since getting a lower interest rate for only ninety days does not involve much of a loss, the bond would sell for something close to $1,000. Hence, while holding any security with a fixed interest rate involves some interest-rate risk, the closer to maturity a security is, the lower is this risk. On the other hand, if interest rates fall you gain because your bond is worth more; and the longer the time until the bond matures, the greater is your gain. But the fact that you may gain as well as lose does not mean that you are taking no risk.

Дата добавления: 2015-08-20