What type of risk occurs because the government could pass a law that would affect your investment?

Answer 1

There is always a risk that a government could pass laws that would affect an investment. In fact, most laws have some bearing on financial matters to a greater or lesser extent.

The word 'investment' is often understood as being the purchase of stocks and shares, i.e. investing on the Stock Market. But there are other types of investments, e.g.

# starting a new business in the hope of making profits # buying some land or capital asset in the expectation of an increase in asset values, over time, in excess of inflation.

Types of legislation that would affect an investment:

* Changes in tax regimes relating to investments, either beneficial or detrimental to investors. * Introduction of, or lifting of restrictive trade laws. These will have either a positive or a negative effect, depending on which sector your investment is placed. * Nationalisation of industries * General changes in tax rates, making companies more or less profitable than they were before the change. * Statutory wage regulations, forcing employers to pay higher wages than the free-market rate. * Depending on which industry you are investing in, 'Green' governmental policies and laws can help or hinder potential for profit. * Restrictions on movements of capital or payments of dividends from companies in foreign countries * Banking laws could be changed, particularly with regard to corporate governance and statutory controls of such institutions. The extent to which governments actually monitor and 'govern' the banks has a big effect on the banks' attitude to risk and reward. Big risks can lead to big profits, but there could be a nasty bite in the tail if the hope of a quick return lures investors into a state of ignoring commonsense precaution. Banks and pension companies are major investors in 'risk' and reward. Laws could be passed that provide greater (or less!) security for the investor. Confidence in the ability of institutions to produce acceptable profits in the short, medium or long term affects share prices. Hypothetical scenarios:

# Someone starts a beauty 'tanning' salon, only to hear that the government, in response to adverse medical reports, is closing all tanning salons within three months. # Oil exploration companies make a big find and start making big profits. Then the government introduces a retrospective 'windfall' tax on oil companies. # An entrepreneur opens a restaurant specialising in obtaining, cooking and serving food originating in a particular foreign country. After week one the government changes its foreign-trade laws and tariffs, forbids the employment of foreign chefs, quadruples profit taxes for all restaurants and imposes a punitive annual licence fee on all restaurant businesses! # A group of investors, academics and professionals set up a medical research centre, funded by investment capital, government grants and sale of research knowledge to the pharmaceutical industry. After one year of massive investment, popular opinion and government action forces the closure of all research establishments in that specialist area! ---- Governmental action affects not only the companies within its own borders, but international trade too. Governments play a major part in controlling/influencing inflation either by legislation or by their own investment strategies which work within their legal frameworks. And share prices, investment values, are all affected by inflation.

Despite governmental action, the world economy seems unstable. Shares prices have soared and plummeted within a very short period of time. And, as outlined above, governments have enormous powers to influence financial and social values, hopefully for the good of all!