Question: List and explain various kinds of risks that an investor may face.

Which of these risks are minimized by purchasing money market instruments? Does investing in the money market avoid all these risks? Answer:
Kinds of Risks: Default Risk: A risk that companies or individuals will be unable to make the required payments on their debt obligations. There is always some positive probability that the borrower will fail to meet some or all of his promised principal or interest payments. To mitigate the impact of default risk, lenders often charge rates of return that correspond the debtor's level of default risk. Liquidity Risk: The risk in lending operations, that an investment cannot be liquidated during its life without significant costs. It is the risk stemming from lack of marketability of an investment that cannot be bought or sold quickly to prevent or minimize loss. Interest Rate Risk: This risk refers to the danger that securities prices will fall, subjecting the holder to a capital loss. Interest rate risk affects the value of bonds more directly than stocks, and it is a major risk to all bondholders. As interest rates rise, bond prices fall and vice versa. The rationale is that as interest rates increase, the opportunity cost of holding a bond decreases since investors are able to realize greater yields by

switching to other investments that reflect the higher interest rate. It is also known as market risk. Market risk is only a problem to if the investors time horizon is shorter than the maturity of the asset. Reinvestment Risk: It is a risk that earnings from a financial asset will have to be reinvested in loweryielding assets at some point in the future. Even government securities carry reinvestment risk. The risk resulting from the fact that interest or dividends earned from an investment may not be able to be reinvested in such a way that they earn the same rate of return as the invested funds that generated them. For example, falling interest rates may prevent bond coupon payments from earning the same rate of return as the original bond. Exchange rate risk: It is the possible loss due to unfavourable changes in the value of foreign currencies. We can also say that it is a risk that a business' operations or an investment's value will be affected by changes in exchange rates. For example, if money must be converted into a different currency to make a certain investment outside Pakistan then changes in the value of the currency will affect the total loss or gain on the investment. This risk usually affects businesses, but it can also affect individual investors who make international investments. Inflation risk: It is the possibility that increases in the average level of prices for all goods and services will reduce the purchasing power of their income. It is the possibility that the value of assets or income will decrease as inflation shrinks the purchasing power

of a currency. Inflation causes money to decrease in value at some rate, and does so whether the money is invested or not.

Which risks are minimized by purchasing money market instruments? Does investing in the money market avoid all these risks? The first kind of risk that can be reduced by purchasing money market instrument is the default risk because when people refer to a money market, they usually mean a money market fund that invests in several different securities at the same time. These securities are selected based on how safe they are, so the default risk is kept to a minimum. Government bonds are a common choice because it is rarer for governments to default than for businesses to do so. The second kind of risk that can be minimized by purchasing money market securities is the liquidity risk because money markets offer superior liquidity allowing the investor to cash securities quickly with little risk of loss of principal. Investing in money market doesnt avoid all of the risks. The investors can mostly avoid liquidity risk and default risk by investing in money markets.