Financial risk

Types of Financial Risks Explained

Financial risk is the possibility of financial loss by financial stakeholders, investors, or shareholders. For example, suppose a business cannot meet its debt obligations. In that case, an investor may lose the money they have invested into the company, or for a government, it would mean defaulting on bonds and other debt repayments. In financial markets, it would mean loss of money due to issues such as macroeconomic issues or the likelihood of default by specific sectors.

Is Gambling Financial Risk?

In case you were wondering, financial risk and gambling aren’t similar even though both involve a sort of probability of gain or loss. For financial risk, there’s a careful consideration of the potential consequences of the choices you make, and you can predict contingency actions.

On the other hand, when it comes to gambling, you usually have the option to have fun for free on platforms like the GGBet site. And even when you spend real money, you are generally doing it for the thrill of it, especially when playing games like online slots, which are purely based on chance. Of course, GGBet casino and other reliable online gaming sites offer games like poker and blackjack where skill is involved, but there’s usually no guarantee of the outcome you should expect.

In a nutshell, financial risk is a risk you can control, whereas gambling is based on chance, or calculated chance at best, where skill is required.

Types of Financial Risk

If you are a business person, it is vital to assess the financial risks that might affect your business or investment and set measures to mitigate loss. They include:

Market Risk

Market risk is the possibility of a loss of an investment by an individual or a firm due to factors affecting the performance of investments in an asset class or the entire financial market. The four sources of market risks include:

  • Equity Price Risk

If you have invested in a security, you expect the price to go up – but this is not always the case. Instead, securities are subject to the risk of a decline in price value, referred to as equity price risk. Therefore, investors should diversify their portfolios into different asset classes such as index funds and mutual funds to mitigate the equity price risk.

  • Interest Rate Risk

Interest rate risk is the likelihood of financial loss by investors due to the fluctuation of interest rates. For instance, if interest rates rise, then fixed-income securities such as bonds will lose value. However, investors can mitigate this risk by investing in bonds with different durations or hedging the fixed-income securities with options or interest rate swaps.

  • Commodity Risk

Commodity risk is the uncertainty of future prices of commodities that may cause financial loss to buyers or producers. Commodity risk affects buyers if the cost of commodity increases, therefore reducing their profit margin. The risk also affects producers if the price of a commodity decreases, leading to either losses or reduced profits. An investor can hedge on the commodity with a futures contract or forwarding contract to mitigate the risk.

  • Foreign Exchange Risk

It is a risk that occurs when performing an international financial transaction as a result of currency fluctuation. This risk should be a high-priority risk to companies trading in the international markets and exporters or importers of products or services of various countries. An investor can use hedging techniques such as investing in hedged EFTs.

Also Read:  Best assets to buy in your 20s

Credit Risk

Credit risk is the probability that a person will fail to pay a loan or meet contractual requirements. As a result, a lender risks interruption of cash flow, lost principal and interest, and an added collection cost. A lender can assess a borrower’s credit history, repayment ability, capital, and collateral to mitigate credit risk. Instanc,es where credit risk may arise, are: 

  • A borrower is unable to pay a mortgage loan;
  • A government bond issuer is unable to make the principal payment;
  • An insolvent bank cannot return funds owned by a depositor. 

So, if you plan to buy a bond, for example, you should check the credit rating of the bond, i.e., BBB, A, AA, or AAA, ranging from the lowest rating to the highest rating, respectively. The lower the rating, the higher the risk of default. Additionally, to reduce credit risk, a lender can require the borrower to get loan insurance or increase the interest rate if the lender is dealing with a borrower with a low credit score. 

Operational Risk

Also known as human risk, operational risk is the likelihood of loss due to events that might disrupt a company’s day-to-day activities. This type of risk is dependent on management decisions and might not necessarily mean loss of funds, reduced production, or increased overall expenses. Examples of factors that may lead to operational risks include:

  • Hiring less skilled staff due to lower salaries.
  • A systems breakdown, when a company is required to undertake two maintenance activities but performs one due to lack of funds.
  • Hiring third-party companies instead of hiring in house.

Identify Financial Risks and Come up with Countermeasures

It is essential to identify, assess and manage financial risks in your business or investment so that you can protect its economic value. While you may not eliminate risk, mitigation will help your firm stay on its feet even in the toughest of conditions.

Similar Posts

Leave a Reply

Your email address will not be published. Required fields are marked *