Financial risk is an umbrella term for multiple types of risk associated with financing. including financial transactions that include company loans in risk of default. [ 1 ] [ 2 ] Risk is a term often used to imply downside risk. meaning the uncertainty of a return and the potential for financial loss. [ 3 ] [ 4 ]

Types of risk [ edit ]

Asset-backed risk [ edit ]

Risk that the changes in one or more assets that support an asset-backed security will significantly impact the value of the supported security. Risks include interest rate, term modification, and prepayment risk.

Credit risk [ edit ]

Credit risk, also called default risk. is the risk associated with a borrower going into default (not making payments as promised). Investor losses include lost principal and interest. decreased cash flow. and increased collection costs. An investor can also assume credit risk through direct or indirect use of leverage. For example, an investor may purchase an investment using margin. Or an investment may directly or indirectly use or rely on repo. forward commitment, or derivative instruments.

Foreign investment risk [ edit ]

Risk of rapid and extreme changes in value due to: smaller markets; differing accounting. reporting. or auditing standards; nationalization. expropriation or confiscatory taxation; economic conflict ; or political or diplomatic changes. Valuation, liquidity, and regulatory issues may also add to foreign investment risk.

Liquidity risk [ edit ]

This is the risk that a given security or asset cannot be traded quickly enough in the market to prevent a loss (or make the required profit). There are two types of liquidity risk:

• Asset liquidity — An asset cannot be sold due to lack of liquidity in the market — essentially a sub-set of market risk. This can be accounted for by:

• Widening bid-offer spread

• Making explicit liquidity reserves
• Lengthening holding period for VaR calculations

Market risk [ edit ]

The four standard market risk factors are equity risk, interest rate risk, currency risk, and commodity risk:

• Equity risk is the risk that stock prices in general (not related to a particular company or industry) or the implied volatility will change.
• Interest rate risk is the risk that interest rates or the implied volatility will change.
• Currency risk is the risk that foreign exchange rates or the implied volatility will change, which affects, for example, the value of an asset held in that currency.
• Commodity risk is the risk that commodity prices (e.g. corn, copper, crude oil) or implied volatility will change.

Operational risk [ edit ]