The different types of risk in finance
Financial risk is a risk of losing money due to a financial transaction (on a financial asset) or an economic operation with financial implications (for example a sale on credit or in foreign currency).
There are many risks, some are specific others not, but the vast majority class in risk below.
- 1 Market or volatility risk
- 2 Credit risk
- 3 The list of risks in finance
- 4 Operational risk
- 5 Exchange rate risk
- 6 Rate risk
- 7 Liquidity risk
- 8 Basic or intrinsic risk
- 9 Risk classification
- 10 Specific case study
- 10.1 Real estate (rental)
- 10.2 Crowdfunding real estate
- 11 Frequency of risks
- 12 Influence of the risk
Market or volatility risk
It is the risk of loss that may result from fluctuations in the price of the financial instruments that make up a portfolio.
The risk may be on the course of stocks, interest rates, exchange rates, raw material prices, etc.
By extension, it is the risk of economic activities directly or indirectly related to such a market (for example an exporter is subject to exchange rates, a car manufacturer in the price of steel…). It is due to the evolution of the whole of the economy, taxation, interest rates, inflation, and also the sentiment of investors towards future developments… It more or less affect all securities.
In modern portfolio theory, this risk is generally measured by the volatility of the market, a statistic.
It's the risk of non-repayment of a debt by a borrower (applies to debt such as bonds sovereign or Treasury bonds).
It is the risk to a creditor of permanently losing his claim insofar as the borrower may not, even by liquidating all of its assets, pay off all of its commitments. Traders speak of "counterparty risk". Counterparty risk is a similar term.
The list of risks in finance
There is a risk that could intervene in the current activity. These risks are so numerous that it is impossible to name them all.
Example of the Bank as a computer problem, a mistake of trading or a dispute. For this banking institutions put in place of verification of each operation procedures.
technology is exceeded or replaced
The risk of strike, turnover, death with the company killed me, the bad reputation etc.
You quote for example the inadequacy of the sales network
the threat of new entrants
If the sector is especially lucrative.
Impossible to buy at a good price or have access to a resource
Risk that clients put pressure
It reflects the risk associated with a political situation or political a decision of power: nationalization without due compensation, revolution, exclusion of certain markets, discriminatory taxation, inability to repatriate capital…
Law or regulatory change can directly affect the profitability of an economic sector (products pharmaceuticals, banking, insurance, energy…).
Exchange rate risk
It's a risk which occurs during the investments abroad (borrowing in dollars for example) and for financial products in currency foreign.
A rise of the dollar against their currency is a cost for the establishment, it may nevertheless cover risks by financial instruments of coverage.
This is the risk that the credit rates change unfavorably. Thus, a floating rate borrower undergoes a rate risk when rates rise, because it must pay more. Conversely, a lender takes a risk when rates fall, because it loses revenue.
That's the risk on the ease to buy or sell an asset. If a market is not liquid, you may not find a buyer when you want or can't find a seller when you absolutely need. This is a risk associated with the nature of the underlying (of goods) but also to the credibility of the buyer-seller. Indeed, it is easy to buy or sell a product at a consideration for confidence, but harder with a very specialized product. It is the liquidity of this product. In addition, if the buyer/seller is not credible, the counterparty risk for potential suppliers/customers deters them to deal with.
For a Bank, it's the risk of finding themselves unable to cope with a massive withdrawal of deposits by customers. If this risk is likely to be extended gradually between banks (domino effect), including, either dried up interbank lending, either of psychological contagion among depositors, we talk about systemic risk, because the system as a whole s´ecroule.
Basic or intrinsic risk
Linked to the evolution of an underlying course and it can consolidate many risks. Weather risk for prices of raw materials like wheat, risk countries, risk from home if you buy in stone etc.
There are other types of risks, but most can get closer definitions presented here.
The risk of inflation. It is the risk to get a refund in a currency depreciated, for a rate of return lower than the inflation rate. Among other things, it caused the ruin of the grandchildren of the annuitants of Balzac.
The risk of fraud.
It can be internal or external to the company.
These are for example those of a storm, an earthquake, a volcanic eruption of a cyclone, a tidal wave that destroyed assets (buildings, machines…). The recent period has shown us that these could not be overlooked.
The economic risk
Enthusiasm or "Blues" on the stock exchange, anticipation of decline or increase in activity.
It is very difficult to classify risks, but some have tried, and have classified the risk into two categories
- economic risks (risks related to the business activity, political, natural, risk of inflation and scam…): what are the risks that threaten flows related to the financial title and under the control of the economic world or the real world.
- financial risks (liquidity risk, Exchange, rate…) that do not directly focus on flows and which are unique to the financial sphere. These risks are not attributable to the company but to external financial events
Specific case study
Real estate (rental)
The market risk
It's an often overlooked risk because it y had big price rises and we forget to say that real estate is a particularly cyclical market the problem of bubbles and breakdown of these last. The risk is not fictional and the fluctuations of the real estate market have nothing to envy to the stock markets.
The risk of holiday rental
The risk is known and feared by all owners. Rental holidays come greatly start good profitability. One month's rent, it's as much decline in revenues. Fixed costs (property tax, charges) are to be paid little matter the level of occupation of the property, then as much as praise him as the long as possible.
The conflict with the tenant
The conflict with a tenant can be a great source of as well financially as lost time. It is quite possible that a tenant invokes a defect (leak, crack or any other pretext) rightly or wrongly for not paying her rent. This can go very far: findings of bailiffs, courts. For a wrongful owner, this can go very far also (amenities). The excess of candle-end savings or are otherwise can for example start a good profitability.
The risk of chargebacks
Tenant who lost are work, conflict can cause a risk of major outstanding.
The risk of deterioration in the good
Unscrupulous tenants are still possible, despite the fact of careful and select tenants.
The defects and work
More classic works that are delayed, costs additional etc are commonplace. But the major defects happen rarely (see curve farmer) but can really be a problem.
Company that goes bankrupt
How many times the construction companies are failures? Sometimes with forget to pay insurance for complete good owner meet the beak in the water.
Crowdfunding real estate
The risk of loss of capital and liquidity
There is first of all of the risks inherent in investments in unlisted securities of companies. There is a risk of loss of capital, total or partial, and a liquidity risk (funds are blocked). These risk position of de facto crowdfunding real estate as an investment for diversification.
Real estate risk
A real estate transaction is not without risk. Risk of project delay, risk of failure of a sub on, too high prices leading to a difficult marketing, use of a third party.
Frequency of risks
Say that there is no risk, it is a blindness, a failure very serious for a financier.
I present to you the Farmer curve, I just think qu´elle represents very well the risks and qu´elle speaks for itself.
Influence of the risk
But the simple fact to know that a company is subject to significant risks will lead some investors to be reluctant to acquire securities. the perception by investors that future flows of a company are uncertain (i.e. volatile) will reduce the value of a title in the eyes of investors then the materialization of the risk is not even effective.
Finance is based on the assumption that investors are seeking to reduce the randomness of their future flows. It is just that a normal person is risquophobe, she dislikes risk.
By nature, a risk will make uncertain the future flows that must generate an asset: this item will therefore be taken into account in the assessment of the value.
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