with Raziah Ahmed
about three quarters of the world's 6.2 billion people live
in "developing" countries, surviving on a mere one
quarter of the world's total income. In fact, the poorest
20 per cent of the world's population earn 0.5 per cent of
the world's income, and the richest 20 per cent, earn 79 per
cent of all world income. And as the old cliché goes:
the rich get richer!
Today we continue our discussion on investment risk. Risk
in this scenario is properly defined as "the chance that
the actual outcome from an investment will vary from the expected
Last week we saw that some time ago, a bond had been recalled
on the local market. The perceived risk was thus not the experience
of those investors who were prevented from earning what they
had calculated. In fact, the experience was worse that what
This type of risk is the major risk faced by bondholders,
and it is called "interest rate risk." The market
was paying a lower interest rate on other types of securities,
than was promised to the bondholder, and the bondholder exercised
his option to "call in" the bond. The capital was
returned to the participants.
The bond issuer promptly announced a new bond issue at a lower
rate of return. Ours being a small and a limited market, investors
(mostly the same participants) promptly bought up the bonds,
for a lower rate of return.
Interest rates were the source of the risk.
There are other sources of risk: inflation risk, liquidity
risk, and exchange rate risk, to name a few. Inflation risk
is the risk that the money you invest will not have the purchasing
power in the future as it has today. Inflation risk is usually
related to interest rate risk, and interest rates generally
rise as inflation increases.
For those of us looking forward to rising interest rates,
as the economy "picks up" we must look as well for
its economic partner in trade: rising inflation. If inflation
is to be managed, then interest rates will not rise significantly,
in the typical course.
Liquidity is the ability to easily convert an asset into cash.
Many persons invest in real estate, and find themselves in
retirement, with an inadequate pension cheque. Their dilemma
is compounded when they can't sell off the asset for fair
market value. Many widows and heirs to estates, sell off assets
cheaply, in order to convert them into cash, because too much
in accumulated in the estate as "property" and not
enough though was given to the "cash flow" situation
of the survivors.
Exchange rate risk is the way returns/ income varies as a
result of fluctuations in currency value. Persons, who save
money in foreign currency, participate in the global currency
market. Persons, who invest only in local stocks, in local
currency, do not face exchange rate risk.
With respect to the types of investment vehicles, so far we
have looked at mutual funds, and bonds. Stocks are another
alternative. A stock certificate gives the holder ownership
interests; the owner is said to have "equity" in
the organisation. Certain rights are allowed this owner e.g.
voting rights at annual general meetings.
Stocks are more risky than mutual funds and bonds. The stockowner
has what is called a "residual claim." In other
words, a stock claim will only be paid after all bond obligations
have been settled.
In general, organisation issue bonds or stocks to raise money
to initiate or continue projects. They take money from the
richest 20 per cent of the world's population, and issue "securities."
Such investors have more to gain when the securities earn
huge dividends. And the rich get richer, as the night follows
n Raziah Ahmed is a Registered Financial Consultant