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Capital Market Risk

Capital Market Risk in the Stock Market

Investment in the capital market exposes the investor to capital market risk; investment in long period financial instruments is also accompanied by high capital market risks.

Stock prices keep changing over a wide range unlike the bank deposits or government bonds. This has a considerable effect on not only the individual investors or the household but the whole economy. The well-organized market hypothesis shows the effect of fundamental factors in changing the price of the stock market. The well-organized Market Hypothesis shows that all price movements are random whereas there are ample of studies that reflect the fact that there is a precise trend in the stock market prices over a period of time.

Research has shown that there are certain psychological factors that form the stock market prices. Occasionally people tend to see patterns and make 'noise' although no such patterns may exist; Individuals are also victims of group thinking.

Capital Market Risk in the Bond Market

There are market participants who own the bond, collect the coupon and hold it till the end of the maturity date; these market participants do not face any capital market risk. Capital market risk is faced by individuals who purchase or sell the bonds before it expires. Capital market risk in the bond market occurs due to interest rate changes. There is an opposite relationship existing between the interest rate and the price of the bonds. Interest rate changes arise due to a change in the monetary policy of the country and such interest rate changes lead to the change in the bond prices in the reverse direction. So the bond prices are sensitive to the monetary policy of the country as well as economic changes.

Sometimes the market behaves irrationally to any economic news. The stock market prices can be diverted in any way in answer to press releases, rumors and mass panic. The stock market prices are also subject to speculation, in the short run the stock market prices may be very volatile due to the occurrences of the fast market varying events.

Capital Markets