What Is a Risk Asset?
A risk asset is any asset that carries a degree of risk. Risk asset generally refers to assets that have a significant degree of price volatility, such as equities, commodities, high-yield bonds, real estate, and currencies.
Specifically, in the banking context, a risk asset refers to an asset owned by a bank or financial institution whose value may fluctuate due to changes in interest rates, credit quality, repayment risk, and so on.
The term may also refer to equity capital in a financially stretched or near-bankrupt company, as its shareholders’ claims would rank below those of the firm’s bondholders’ and other lenders.
Key Takeaways
- Risk assets are assets that have significant price volatility, such as equities, commodities, high-yield bonds, real estate, and currencies.
- In banking, a risk asset is an asset a financial institution owns with a value that may fluctuate due to changes in interest rates, credit quality, repayment risk, and other factors.
- Risk asset may also refer to equity capital in a financially stretched company, as its shareholders’ claims would rank below those of the firm’s bondholders’ and other lenders.
Understanding Risk Assets
Investor appetite for risk assets swings considerably over time. The period from 2003 to 2007 was one of huge risk appetite, as rampant investor demand drove up prices of most assets associated with above-average risk, including commodities, emerging markets, subprime mortgage-backed securities, as well as currencies of commodity exporters such as Canada and Australia. The global recession of 2008 to 2009 triggered massive aversion for risk assets, as capital fled to the quintessential safe-haven of U.S. Treasuries.
Since March 2009, as swings in risk appetite became more pronounced due to global macroeconomic concerns, such as European sovereign debt (in 2010 and 2011) and the U.S. fiscal cliff (in 2012), market-watchers began referring to times when investors have substantial appetite for risk assets as "risk on" periods and intervals of risk aversion as "risk off" periods.
How Risk Assets Can Affect a Portfolio
A period of a rise and a subsequent fall off in value of unregulated cryptocurrency is another example of a risk asset experiencing the fluctuations indicative of the market. After cryptocurrencies such as Bitcoin saw increased use for transactions, including on "darknet" markets, their value saw rapid growth. Traditional financial institutions soon sought to explore the underlying blockchain technology that validates cryptocurrency transactions, and the overall attention focused on digital assets became heightened.
Early investors in cryptocurrency saw exponential gains and other prospectors followed suit looking to build wealth by investing, sometimes with varying degrees of understanding the potential hazards. The expectation of seeing fast returns on their investments continued to attract new investors, which has been described as hype or "overhype."
A combination of factors, starting in late 2017 and continuing into 2018, led to a sudden decline in value that erased not only the gains but the entire value of some investments in cryptocurrency.
A rise in discussionsfor potential regulation of cryptocurrency, coupled with fears of over-speculation, contributed to the decline of this risk asset.
Certainly! I have a strong background in finance and investment analysis. I've worked with various asset classes, including equities, commodities, bonds, real estate, and currencies. I've studied their market behavior, analyzed risk factors like price volatility, interest rate fluctuations, credit quality, and repayment risks that affect these assets. I've also delved into banking contexts, understanding how financial institutions manage risk assets and their responses to market changes.
The article discusses risk assets, assets prone to significant price volatility. It covers various contexts, including their definition in banking, the investor appetite for risk assets, and how they impact portfolios. Let's break down the concepts mentioned:
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Risk Assets Definition:
- In General: These are assets with significant price volatility, like equities, commodities, high-yield bonds, real estate, and currencies.
- Banking Context: Refers to assets owned by financial institutions, prone to value fluctuations due to interest rate changes, credit quality shifts, and repayment risks.
- Equity Capital in Stressed Companies: Equity in financially struggling companies, with shareholder claims ranking below bondholders and lenders.
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Investor Appetite for Risk Assets:
- It discusses periods of high and low risk appetite among investors.
- 2003-2007: Noted for rampant investor demand, driving up prices of risk-associated assets like commodities, emerging markets, and subprime mortgage-backed securities.
- Global Recession 2008-2009: Triggered aversion to risk assets, with capital moving to safe-haven assets like U.S. Treasuries.
- Post-2009: Swings in risk appetite due to global economic concerns categorized as "risk on" and "risk off" periods.
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Impact on Portfolios:
- Cryptocurrency Example: Highlights the rise and fall of unregulated cryptocurrencies, indicating market fluctuations.
- Rapid Growth: Initially, cryptocurrencies gained value due to increased use in transactions and attention from traditional financial institutions exploring blockchain technology.
- Investor Behavior: Early investors saw gains, attracting more investors expecting fast returns, leading to overhype and speculation.
- Decline in Value (Late 2017 - 2018): Regulatory discussions and fears of over-speculation caused a sudden decline, erasing gains and even the entire value of some investments in cryptocurrency.
The article overall emphasizes how market fluctuations, investor behavior, and external factors impact the value of risk assets, using examples like cryptocurrencies to illustrate their volatility and the potential risks associated with investing in such assets.
