Balancing Act: Navigating Investment Risk in an Uncertain World

It happens in cashflow problems especially when these assets’ markets are on a downward trend. The slow movement of these assets may be due to increasing interest rates which result in low demand. In such scenarios, the assets can only sell at a bargain which may lead to losses.

For this reason, investors should consider asset liquidity for long-term and short-term investment decisions as the ease of disposal affects their prices.

Foreign exchange risk - this is a common risk faced by international investors. Foreign exchange risk is a measure of the variability of domestic currency values of assets, liabilities or incomes as a result exchange rate fluctuation (Levi 282). Macroeconomic conditions and government policies such as currency devaluation cause these fluctuations. For instance, if you invest in emerging markets and their currencies depreciate, the value of your investment could be worthless when you convert it back to your domestic currency say, the dollar or euro. Similarly, if you hold mortgage denominated in a foreign currency, the interest rate values will consequently increase with the depreciation of the domestic currency.

From the scenarios above, it is clear that all incomes, assets, and liabilities are affected by exchange rate fluctuations, and investors should hedge themselves to avert any losses. These fluctuations can also work to the investors’ advantage. 

Risk Mitigation

The various risks discussed above can be mitigated as follows:

Interest rate risk can be minimized using derivative contracts. The contracts that apply to this case are forwards and swaps. For forwards, there is the determination of the forward rate and an assurance given to such holders of receiving or paying certain payments after the agreed-upon period. Interest rate swaps apply to companies with different interest rate obligations, that is, fixed rate and a floating rate. With the two, they can swap their obligations thereby, allowing each company to pay the most suitable price.

For liquidity risk, investors are advised to hold a bundle of assets with different maturity periods which will ensure that they meet their short-term needs as they focus on long-term goals. Some of the short-term instruments to include: treasury bills and notes, call deposits and money market instruments offered by mutual funds. For the long term, investors can focus on equities, bonds and alternative investments which guarantee attractive returns. Such a portfolio will ensure an adequate flow of income to meet both short-term and long-term obligations as they fall due.

In the case of currency risk, the best mitigation alternative is derivative contracts. Examples of these instruments include; currency options, forwards, future, swaps, and the money market hedge (Levi 337). With careful analysis and selection of these instruments, there is a guarantee on the safety of the investment. Additionally, investors can make a riskless profit from these operations.

Conclusion

From the discussion herein, it is clear that every investment operation carries risk and reward thereof. It is of significance for investors to evaluate the available investment alternatives, their risk tolerance, and their investment incomes before investing in any instrument. These tools, coupled with analytical skills will enable them to track the performance of their portfolios. 

Work Cited

Chambers, Donald R., et al. Alternative Investments: CAIA Level I. John Wiley & Sons, 2015.

Graham, Benjamin, and Jason Zweig. The intelligent investor. New York, USA: Harper Business Essentials, 2003.

Levi, Maurice D. International finance 5th edition. Routledge, 2014.

Petty, J. William, et al. Principles of Financial Management. Pearson Australia, 2015.