Risk asset is a broad umbrella term used to describe any financial security or instrument that is not risk-free, and generally refers to assets that are likely to fluctuate in prices.
The risk assets examples include equities, commodities, high-yield bonds, real estate, and currencies (forex).
Under the legal risk assets definition, the term refers to fixed-income securities that are not investment-grade securities, common stock, preferred stock, mortgage loans and real estate.
Risk assets explained
Investing in risk assets means there is a possibility that the value of the asset may rise or fall because of fluctuating interest rates, changes in credit quality, default risks, supply and demand disruption, and other factors.
For example, if you owned shares of a company that went bankrupt, you may lose the full purchased value of the stock and will have to stand in line behind other creditors to recoup any capital.
In banking, any bank-owned asset whose value may change due to fluctuating interest rates, changes in credit quality, repayment risk, and other factors, are considered as risk assets.
For example, the value of mortgages, derivatives, and corporate bonds are subjected to change depending on the above-mentioned factors.
High-risk vs low-risk
Economists and investors considered all areas of fixed-income as risk assets, except for high-quality sovereign bonds, such as Treasuries or gilts.
US Treasury securities are considered low-risk assets as these debt instruments are backed by the US government, which guarantees the interest – known as coupon – and principal payments will be paid on time. For a risk-free asset, the expected return is always the same as the actual return.
In contrast, high-risk investments are exposed to price volatility and generally provide higher returns, but also carry a significant risk of price crash, which could wipe out the value of the asset.
An example of a high-risk asset is cryptocurrency, with some coin prices rising exponentially in the early days of listing on exchange, but suffering a downturn because of waning investment interest or other factors.
Growth stocks are also considered high-risk assets, as they tend to have lofty valuations based on expectations of future profits.
The bottom line
Professional investors or trading firms assess the suitability of financial instruments in a portfolio by measuring the risk of an asset. The risk assessment for assets is the measure of the default potential or market value fluctuation.
An individual’s portfolio composition will depend on their risk tolerance, aims and investment horizon, which is the period that they are willing to have no access to the investment money.
