Financial risk

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Financial risk is any of various types of risk associated with financing, including financial transactions that include company loans in risk of default.[1][2] Often it is understood to include only downside risk, meaning the potential for financial loss and uncertainty about its extent.[3][4]

A science has evolved around managing market and financial risk under the general title of modern portfolio theory initiated by Dr. Harry Markowitz in 1952 with his article, "Portfolio Selection".[5] In modern portfolio theory, the variance (or standard deviation) of a portfolio is used as the definition of risk.

Asset-backed risk is the risk that 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 .

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 is the 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.

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:

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

Financial risk, market risk, and even inflation risk can at least partially be moderated by forms of diversification.

This page was last edited on 19 July 2018, at 21:04 (UTC).
Reference: under CC BY-SA license.

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