Economics of Financial Markets types of risk

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  • Types of Risk
    • Investment risk
      • we don't know for sure which rate of return to expect from the investment
    • Asymmetric risk
      • the unequal knowledge that each party to a transaction has about the other party
    • Credit risk
      • possibility that borrower will default
    • Default risk
      • chance that the issuer will be unable to make interest payments or pay off the face value once the instrument matures
    • Inflation risk
      • possibility that inflation exceeds the returns of the investment
    • Interest rate risk
      • possible reduction in returns associated with interest rate changes
    • Systematic risk
      • (market risk) part of an asset's risk which cannot be eliminated through diversification
    • Political risk
      • policy makers have an influence on returns
        • e.g. raise taxes on capital gains
    • Moral Hazard
      • Risk that 1 party in a transaction will engage in behavior that is undesirable to the other(s)
    • Adverse selection
      • Caused by Asymmetric information before transaction occurs
      • Those who are viewed as undesirable are the ones who are most likely to want to engage in transaction

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