08.30.06
Risk Considerations
As an investor, it is critical to look at risk and reward ratio and compare various investment options. As the first step, it is important to categorized risk into various categories: firm specific, sector specific, market wide and global.
- Firm specific risks are primarily associated with a single company. These risks have a wide range of dimensions from misjudgment of customer demand to improper setup of a company’s supply chain. Firm specific risks could be reduced or potentially eliminated by properly understand the firm and its operations.
- Sector specific risks expand beyond a single company and have impacts on a particular sector (i.e. transportation, automobile or retail). For example, when oil price rises, it has a significant dampening effect on airline sector where fuel expense is a main component of operation expense. In this case, oil price increase will have major impact on airline sector, some impacts on retail, but very limited impact to gold mining. Sector specific risks could be reduced somewhat, but less so compare to firm specific risks.
- Market wide risks such as interest rate movement are more pervasive and affect many if not all companies. Market wide risks could be predicted somewhat, but not eliminated
- Global risks are new type of risks we see in the market place. Because of the globalization, change from one part of the world will have major impacts on the other part of the world. For example, India or China political uncertainty will have a direct impact to companies around the world that outsource their manufacturing facilities or call centers to these countries. Global risks require specific regional knowledge and could be reduced by involving regional experts.
When we look at investment options, let’s be sensitive to all the risk factors and then find the best value to compensate for that risk.
