How to minimize the risk of an investment with risk coverage
Risk is an inherent element in all investments. This is a contingency that, in many cases, must be considered to prevent market volatility from putting an investor’s capital or collection rights at risk, like what had happened with GWG Holdings. To do this, some instruments are used that allow risk coverage.
In general, this type of instrument usually takes the form of insurance or guarantee whose objective is to preserve the investors’ assets. In some cases, the coverage of the risks is not possible or entails costs that, in practice, mean that the effort of this coverage does not compensate for the risks.
The risks inherent in the investment process
Investors, throughout their entire decision process, are continuously defining the risk of their portfolio based on their profile. The choice between fixed or variable income, financial instruments and products, or the allocation of assets and their diversification are decisions that, from the outset, determine the risk of the investment.
However, some risks are inherent to any investment process, regardless of the type of asset is chosen and the composition of the portfolio. The most common are the following:
- Currency risk, arises as a result of the trading of two currency pairs, especially when part or all of an investor’s portfolio is denominated in a different currency.
- Interest rate risk, which directly affects fixed-income assets (the price of bonds) and indirectly affects variable-income assets. It largely depends on monetary policy decisions.
- Market risk is derived from political or economic situations or situations that negatively affect the price of an asset or portfolio.
- Credit risk is very common in fixed income assets. It occurs when the issuer of debt cannot return the capital or interest to the creditor on the date agreed in advance.
The main instruments for hedging risks
There are different ways to carry out a correct risk coverage, each of which has its function and its particularities. These are the most common.
Derivative products are contracts that allow you to buy or sell a certain underlying asset at maturity, and for a certain price. The best known are futures and options, although they are not the only ones.
Thus, for example, a company can acquire an asset on a specific date and for a price agreed in advance, thus avoiding market volatility and ensuring its price. Of course, in this case, you can miss the potential profits that may occur.
Diversification of uncorrelated assets
In this case, the objective is not so much to invest in a financial instrument as such, but rather to make a portfolio composition so that the increases and decreases in the price of the assets offset each other. To do this, the diversification of the portfolio must have a set of assets that are sufficiently uncorrelated with each other.
The most paradigmatic case is an investment in fixed income and variable income assets simultaneously. In general, when one of them falls, the other increases its price and vice versa. Many portfolios also contain gold for its role as a safe-haven asset in times of uncertainty.
There are different hedging instruments offered by entities, the best known of which is the swap. It is a financial exchange agreement in which one of the parties agrees to pay a series of monetary flows in exchange for receiving another series of flows from the other party.
Thus, for example, a particular client could, for example, acquire a swap to transform the variable payments of his mortgage linked to the Euribor for payments at a fixed interest rate, to ensure the flow of payments for his investment. It is also a widely used instrument for hedging two currency pairs in international trade. By visiting this game đánh bài online, you can play the online casino as well.
Insurance and guarantees
It is, perhaps, the best-known risk hedging instrument. Insurance is configured as an interesting option to minimize the risk of an investment. In exchange for the payment of a premium, the insurance guarantees that a certain operation is completed with values agreed in advance. In some cases, guarantees are also used, which serve as an additional guarantee of collection.
There are all kinds of insurance, such as those used in foreign trade to fix the value of a currency or credit insurance, which guarantees the payment of a debt if the debtor cannot pay it on time. In guaranteed products, insurance is also used that always guarantees a positive return, in exchange for the participants paying a certain premium.
Even with all guarantees, you are somehow victimized to fraud as in the case of GWG L Bonds, then definitely you can go for a Lawyer for GWG Bonds.