There are many risks associated with capital market trading that may impair investments.
Risks associated with shares:
Company (issuer) risk
Each buyer becomes a company shareholder, thereby taking part in its development and any profit or loss. All risks are usually reflected in the current market value – the returns on such investments are thus difficult to predict. In extreme cases, the given company may even go bankrupt and the entire investment may be lost.
Price risk
Prices of shares may be subject to unpredictable fluctuations, resulting in potential losses. Prices go up and down in the course of medium-term and long-term cycles, without any way of determining the duration of such cycles. This is general market risk, associated with market sentiments, global political situation and situation prevailing in the financial markets. This risk must be distinguished from risks specific to a company.
Dividend payment risk
Dividend per share mainly depends on revenue of the issuing company as well as its dividend policy and development plan. In case of low profits, dividend revenue may be reduced or not paid out at all.
Currency risk
Investments in shares denominated in foreign currencies are also associated with currency risk. Investments may not be profitable in CZK equivalent, in spite of increasing market prices of share.
Risks associated with bonds:
Interest rate risk
Interest rates and bond prices carry an inverse relationship. As interest rates fall, the price of bonds generally rises and, conversely, when interest rates rise, bond prices tend to fall. Uncertainty relating to interest rate changes means that investments in fixed-rate securities are associated with the risk of declining prices of such securities, when interest rates rise. The longer the maturity and the lower the interest rate, the higher the bond sensitivity to rising market rates.
Inflation risk
Investors buying bonds essentially commit to receiving a rate of return, either fixed or variable, for the duration of the bond or at least as long as it is held. In case inflation increases dramatically, and at a faster rate than investment income, investors may actually achieve a negative rate of return.
Credit risk
Investors must consider the possibility of bond issuer’s temporary or permanent default, not being able to repay the coupon or principal in time. In their investment decisions, clients must factor in the possibility that corporate and municipal bonds are not guaranteed and that they may lose their initial investments, either in part or in full.
Rating downgrade risk
Issuers’ ratings are published by ratings institutions. They assess company’s ability to manage and repay its debt. If a company's credit rating is low or its ability to repay is questioned, banks and lending institutions may charge the company a higher interest rate for future loans. This further impairs the company's ability to satisfy its debts, prices of existing bonds decline, and existing bondholders incur losses when selling their bonds.
Liquidity risk
Government bonds usually do not have any problems with market liquidity. However, the situation may be quite different for other types of bonds. Bonds traded on a thin market may be sold at lower prices than those expected by investors on the basis of standard reports.
Prepayment risk
In its prospectus, an issuer may reserve the right to bond prepayment (call option), usually exercised in case of declining market interest rates. Therefore, investors may not generate expected returns to maturity.
Currency risk
Investments in bonds denominated in foreign currencies are also associated with currency risk. Investments may not be profitable in CZK equivalent, even if an investor holds the given instrument to maturity.
