Man climbing a rope
Independent risk describes the danger associated with investing in a specific instrument or investing in a specific division of a company. A typical investment portfolio contains a wide range of instruments, in which case investors are exposed to a large number of potential risks and rewards. In contrast, an independent risk is one that can be easily distinguished from these other types of risk.
When an investor invests in a single type of stock, the entire return on their investment depends on the return on that security. If the company that issued the shares performs well, the shares will increase in value, but if the company becomes insolvent, the shares may lose value. Therefore, this investor is exposed to autonomous risk because this individual’s entire investment could be lost due to the poor performance of a single asset. Additionally, someone who invests in a wide range of securities is also exposed to autonomous risk if that person holds each type of instrument in a separate brokerage account. In such situations, the investor would not lose everything if an asset went down in value, but each deposit account would expose the investor to a different autonomous risk, since each account would only hold one type of security.
As private investors, large companies, including investment firms, are exposed to autonomous risks. The flood insurance division of a large finance company is exposed to the risk that a large number of hurricanes or coastal flooding could cost the company a significant amount of money in terms of policy payouts. The auto insurance and health insurance divisions of the same company would not expose the company to this same risk because these types of policies do not provide the insured with water damage claims.
Many investors try to address independent risk by expanding portfolios to include other types of bonds and assets. An insurer cannot completely eliminate the risk associated with flooding by selling other types of policies, but a company that sells life, health, and auto insurance is less likely to experience financial problems after a major storm than a company that sells only policies. against floods. Structurally, some companies register different departments of the company as separate legal units to protect the entity from the risks associated with a division of the company or a type of asset. If all of a company’s holdings operate as a single structure, the company’s creditors and investors may seek compensation if the bankruptcy of a division of the company causes these groups and individuals to lose money.