Types of Financial Risks
What are Financial Risks
Financial risks are the potential for losing money on an investment or business endeavor. Financial risks come in a variety of forms, including operational risk, credit risk, and liquidity risk. A potential loss of capital to an interested party is a financial risks.
Financial risks, then, are a threats that may result in a loss of capital. It has to do with the chances of losing money.
It is possible that a company’s cash flow won’t be sufficient to meet its obligations in the event of a financial risk. Credit, operational, foreign investment, legal, equity, and liquidity risks are a few typical financial hazards.
Types of Financial Risks
Risk can be defined as the possibility of an unexpected or bad consequence. Risk can be defined as any action or behavior that results in any form of loss. There are various types of dangers that a company may encounter and must overcome. Risks are broadly grouped into three categories:
- Business risk
- Non-business risk
- Financial risks.
These are the risks that businesses face in order to maximize shareholder value and profits. Companies, for example, will take high-risk marketing risks to launch a new product in order to increase sales.
These are hazards over which enterprises have no control. Non-business risks are those that develop as a result of political and economic imbalances.
As the name implies, financial risk is the risk of a firm’s financial loss. Financial risks often emerges as a result of financial market volatility and losses caused by changes in stock prices, currencies, interest rates, and other factors. Financial Risks further classified into four important types.
- Market Risk
- Credit Risk
- Liquidity Risk
- Operational Risk
This form of risk has a very broad scope because it develops as a result of supply and demand dynamics.
Market risk is primarily created by economic uncertainty, which can have an impact on the performance of all organizations, not just one. These sources of risk include changes in the prices of assets, liabilities, and derivatives.
This is the risk that an importer company faces when it pays for supplies in dollars and then sells the finished product in local currency. In the event of a depreciation, the company may incur losses that prevent it from meeting its financial obligations.
The same is true for market innovations and developments. The commercial sector is one example. Companies who have successfully adapted to the internet marketplace to sell their goods have seen an upsurge in sales. Those who have resisted these changes, however, exhibit a lack of competitiveness.
This risk relates to the potential that a creditor won’t get paid for a loan or gets paid late. In order to assess a debtor’s ability to meet its financial obligations, credit risk is used.
Retail and wholesale credit risks are the two different categories. The first is the risk associated with providing credit to consumers and small businesses, whether through mortgages, credit cards, or other means. On the other hand, wholesale credit results from an organization’s own investments, whether they take the form of financial asset sales, corporate mergers, or acquisitions.
Subprime mortgages were high-risk, high-interest loans made to people who were unemployed or did not have a consistent source of income.
In order to enhance income, banks sought to broaden the profile of subprime mortgage applicants. However, because the applicants were unable to pay, the debts became delinquent.
This issue caused the failure of thousands of institutions in the United States and jeopardized the reputation of others, including JP Morgan Chase.
Every corporation must ensure that it has enough cash flow to pay off its debts, therefore financial risk management must address a company’s liquidity. Failure to do so risks undermining investor trust.
Liquidity risk is precisely that. It is the chance that a corporation will be unable to meet its obligations. Poor cash flow management is one of the possible causes.
A corporation might have large equity while also having a high liquidity risk. This is because it cannot convert those assets into cash to cover its immediate needs. Real estate or bonds, for example, can take a long time to convert into cash.
There is also operational risks among the various sorts of financial hazards. There are various kinds of operational risk. These hazards arise as a result of a company’s lack of internal controls, technical failures, mismanagement, human mistake, or a lack of personnel training.
This risk almost always results in a financial loss for the organization.
One of the most difficult to quantify objectively is operational risk. To be able to compute it accurately, the organization must have kept a history log of failures of this type and recognized the potential link between them.
These hazards can be avoided if a given risk is thought to be capable of triggering further dangers. A broken machine, for example, not just indicates the cost of repairing it.
Facebook and Intel have faced such type of operational risk and World’s biggest banks viz: Barings Bank Riggs Bank.
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