LeoGlossary: Risk (Financial)
In financial terms, risk is the chance that an outcome will be different from what is expected. Essentially, it is the likelihood of losing money on an investment or business decision. In other words, it is an end that results in the loss of capital.
When making investments, individuals have to factor in their tolerance for risk before entering.
There are many efforts to quantify risk including utilizing standard deviations from historical norms. At the same time, there are some risks that are in control of a corporation or individual while others are not. Being able to monitor all of these is important, especially for CEOs.
For example, one of the financial risks facing a corporation is the possibility that cash flow from operations will not be sufficient enough to meet the current expenses.
Types of Risk
Risk can have a negative outcome. That is why much attention is given to mitigating it. It is vital to understand the different types of risk that exist.
- Business risk - risks arising out of the actions taken by a business in the quest to increase revenues and profits. This is done in order to maximize shareholder (or owner) value.
- Non-Business risk - risks completely outside the control of a business. This can be political or economic, such as the threat of a recession.
- Financial risk - the loss of money due to movements in financial markets. This can be due to drop in stock prices, currency exchange rates, interest rates, and other financial conditions.
Types of Financial Risk
- Market - risk arises due to the movement in prices of financial instrument including an increase in volatility.
- Operational - failures due to mismanagement of the firm. This could end up leading to fraud as protocols and procedures were missed which allow for someone to take advantage of the situation. In other words, management had a hand in the loss.
- Legal - risks that involve the legal system most often as the potential for lawsuits.
- Liquidity - the inability to execute financial transactions when needed.
- Credit - risk that occurs as a result of counterparties not fulfilling their obligation. This can come both as sovereign or settlement risk.
Financial risks affect businesses in different ways. Successful firms are able to navigate through the perilous waters in an effort to keep increasing their market capitalization.
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