Risk management

Key Takeaways

  1. Risk in finance and investment refers to the unfavorable outcome with an investment or financial asset.
  2. The rationale behind the risk management is to identify, assess and reduce the impact of risks on the businesses.

Risk management is a general requirement not just in the finance world but in each segment. Risk in finance and investment refers to the unfavorable outcome with an investment or financial asset. Understanding the risk, and effectively managing them, helps the organization in achieving long term success. The difference between the actual return on investment and expected return on investment is considered as the risk.

Types of Risk

Systematic and unsystematic risk are the two categories of risk. Systematic risk affects the overall economy or a more substantial part of the market, while the unsystematic risk affects the specific segment of the economic market or an organization. Market risk is an example of systematic risk, where if a recession occurs, it affects all the businesses.

Credit Risk – Credit risk emerges when the borrower does not return the money to the lending party. Most banking institutions face this risk.

Operational Risk – Operational risk arises due to failures of external resources such as shortfall of staff, strike, poor budget allocation, technical failures, frauds, etc. 

Market Risk – The market risk is losses in investment faced by the investor due to fluctuations in the market, which affects the overall productivity and performance of the economy.

Interest Rate Risk – Interest rate risk arises when changes in the interest rates affect the return on investments.

Currency Risk – Currency risk emerges when the foreign exchange rate changes. Most of the MNC’s are prone to this type of risk. It affects the value of an asset. 

Legal Risk – Legal risk emerges because of legal constraints or lawsuits.

Commodity Risk – A risk that occurs when prices of a particular commodity change (example wheat, crude oil), which affects the return on investments.

Equity Risk – a risk that changes index or stocks prices

Liquidity Risk – Liquidity risk arises when a company fails to meet its short term financial obligations.