Answer:
Financial Risks:
Financial risk is the possibility
that shareholders will lose money when they invest in a company that has debt,
if the company's cash flow proves inadequate to meet its financial
obligations. When a company uses debt financing,
its creditors are repaid before its shareholders if the company
becomes insolvent. Financial risk also refers to the possibility of a
corporation or government defaulting on its bonds, which would cause those
bondholders to lose money.
Types of Financial Risks:
1.
Market Risk:
This type of risk arises due to movement in prices of
financial instrument. Market risk can be classified as Directional
Risk and Non - Directional Risk. Directional risk is caused due to
movement in stock price, interest rates and more. Non- Directional risk on the
other hand can be volatility risks.
2.
Credit Risk:
This type of risk arises when one fails to fulfill
their obligations towards their counter parties. Credit risk can be
classified into Sovereign Risk and Settlement Risk. Sovereign
risk usually arises due to difficult foreign exchange policies. Settlement risk
on the other hand arises when one party makes the payment while the other party
fails to fulfill the obligations.
3.
Liquidity Risk:
This type of risk arises out of inability to execute
transactions. Liquidity risk can be classified into Asset Liquidity
Risk and Funding Liquidity Risk. Asset Liquidity risk arises either
due to insufficient buyers or due to insufficient sellers against sell orders
and buys orders respectively.
4.
Operational Risk:
This type of risk arises out of operational failures such as
mismanagement or technical failures. Operational risk can be classified
into Fraud Risk and Model Risk. Fraud risk arises due to lack of
controls and Model risk arises due to incorrect model application.
5.
Legal Risk:
This type of financial risk arises out of legal constraints such as
lawsuits. Whenever a company needs to face financial loses out of legal
proceedings, it is legal risk.
Credit risk:
A credit
risk is the risk of
default on a debt that may arise from a borrower failing to make required
payments. In the first resort, the risk is
that of the lender and includes lost principal and interest, disruption to cash
flows, and increased collection costs.
How
is credit risk assessed?
Credit risks are calculated based on the borrowers'
overall ability to repay. To assess credit risk on a consumer loan,
lenders look at the five C's: an applicant's credit history, his capacity to
repay, his capital, the loan's conditions and associated collateral.
Similarly,
if an investor is thinking about buying a bond, he looks at the credit rating
of the bond. If it has a low rating, the company or government issuing it has a
high risk of default. Conversely, if it has a high rating, it is considered to
be a safe investment. Agencies such as Moody's and Fitch evaluate the credit
risks of thousands of corporate bond issuers and municipalities on an ongoing
basis.
Types of Credit Risk:
1.
Credit default risk:
The risk of loss
arising from a debtor being unlikely to pay its loan obligations in full or the
debtor is more than 90 days past due on any material credit obligation; default
risk may impact all credit-sensitive transactions, including loans, securities
and derivatives.
2.
Concentration risk:
The risk
associated with any single exposure or group of exposures with the potential to
produce large enough losses to threaten a bank's core operations. It may arise
in the form of single name concentration or industry concentration.
3.
Country risk:
The risk of loss
arising from a sovereign state freezing foreign currency payments
(transfer/conversion risk) or when it defaults on its obligations (sovereign
risk); this type of risk is prominently associated with the country's
macroeconomic performance and its political stability.
Comments
Post a Comment