Question

Choose 4 different types of financial risk and compare them, provide example for each type?

Note:

1-Each type need 100 words

2- Total not less than 400 words

3- Repetition NOT allowed

Answer 1

Financial Risk is the risk that involves financial loss to the party. Financial risk generally arises due to instability and losses in the financial market caused by movements in stock prices, currencies, interest rates and many other economic factors. The four different types of risks are as follows:

Credit Risk:

This type of risk arises when one fails to fulfill their obligations towards their counterparties. 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. Some examples are poor or falling cash flow from operations (which is often needed to make the interest and principalpayments), rising interest rates (if the bonds are floating-rate notes, rising interest rates increase the required interest payments).

Market Risk:

This type of risk arises due to the 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. Market risk is sometimes called “systematic risk” because it relates to factors, such as a recession, that impact the entire market. Examples include inflation risk, interest rate risk, equity risk, currency risk and commodity risk. Sources of market risk include recessions, political turmoil, changes in interest rates, natural disasters and terrorist attacks

Liquidity Risk:

‘Liquidity Risk’ means ‘Cash Crunch’ for a temporary or short-term period and such situations generally have an adverse effect on any Business and Profit making Organization. This type of risk arises out of an 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 insufficient sellers against sell orders and buys orders respectively. Examples of liquidity risks include:

1. Inability to meet short-term debt due to exceptional losses or damages during Operations.
2. Unable to meet proper funding within specific time-frame. In most of the Startup funding based Companies, there is a risk of break-even. Thus, if the Business does not get next funding, then there can be a possibility of Liquidity risk.

Operational Risk:

The risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events, but is better viewed as the risk arising from the execution of an institution’s business functions. Operational risk exists in every organization, regardless of size or complexity from the largest institutions to regional and community banks. Operational risk can be classified into Fraud Risk and Model Risk. Fraud risk arises due to the lack of controls and Model risk arises due to incorrect model application.

Examples of operational risk include:

• Risks arising from catastrophic events (e.g., hurricanes)
• Computer hacking
• Internal and external fraud
• The failure to adhere to internal policies