EFIN546 U04L04 Types of Financial Risks.pptx

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1. Types of Financial Risks Risk Models

2. Learning Outcomes After this lecture, you will be able to Understand Financial Risks and their causes

3. Financial risk is the possibility of losing money on an investment or business venture. Financial risk is a type of danger that can result in the loss of capital to interested parties. For governments, this can mean they are unable to control monetary policy and default on bonds or other debt issues. Corporations also face the possibility of default on debt they undertake Financial Risks

4. Some common and distinct financial risks include: credit risk, liquidity risk, operational risk, foreign investment risk, equity risk, and currency risk are all common forms of financial risk. Financial Risks

5. Credit risk is also known as default risk—is the danger associated with borrowing money. Should the borrower become unable to repay the loan, they will default. Investors affected by credit risk suffer from decreased income from loan repayments, as well as lost principal and interest. Creditors may also experience a rise in costs for collection of the debt. C redit risk

6. Liquidity risk comes in two flavors for investors to fear. The first involves securities and assets that cannot be purchased or sold quickly enough to cut losses in a volatile market. Known as market liquidity risk this is a situation where there are few buyers but many sellers. The second risk is funding or cash flow liquidity risk. Funding liquidity risk is the possibility that a corporation will not have the capital to pay its debt, forcing it to default, and harming stakeholders Liquidity risk 

7. Operational risk is the prospect of loss resulting from inadequate or failed procedures, systems or policies.  Employee errors Systems failures Fraud or other criminal activity Any event that disrupts business processes Operational risk

8. Foreign Investment  Risk is the risk of investing in foreign countries. If the Country as a whole is at risk of falling GDP, high inflation, or civil unrest , the investment will lose money. This can include investing in equities in foreign companies or simply making any investment with an entity that is not based in the home country. There can be currency risks, political risk or interest rate risks that may affect investments in foreign countries. Foreign Investment Risk

9. Equity risk  is "the financial risk involved in holding equity in a particular investment ."  Equity risk  often refers to equity in companies through the purchase of stocks. Equity Risk

10. Currency risk, or exchange rate risk, refers to the exposure faced by  investors  or companies that operate across different countries, in regard to unpredictable gains or losses due to changes in the value of one currency in relation to another currency . Currency Risk

11. Fundamental analysis , the process of measuring a security's intrinsic value by evaluating all aspects of the underlying business including the firm's assets and its earnings . Technical analysis , the process of evaluating securities through statistics and looks at historical returns, trade volume, share prices, and other performance data. Quantitative analysis , the evaluation of the historical performance of a company using specific financial ratio calculations. Tools to Control Financial Risk