Risks and Its Types

Topics: Balance sheet, Generally Accepted Accounting Principles, Asset Pages: 15 (3979 words) Published: February 17, 2013
Types of Risk

Stand-Alone Risk 
This risk assumes the project a company intends to pursue is a single asset that is separate from the company's other assets. It is measured by the variability of the single project alone. Stand-alone risk does not take into account how the risk of a single asset will affect the overall corporate risk.

Corporate Risk
This risk assumes the project a company intends to pursue is not a single asset but incorporated with a company's other assets. As such, the risk of a project could be diversified away by the company's other assets. It is measured by the potential impact a project may have on the company's earnings.

Market Risk
This looks at the risk of a project through the eyes of the stockholder. It looks at the project not only from a company's perspective, but from the stockholder's overall portfolio. It is measured by the effect the project may have on the company's beta. This deals with un favorable price or volatility that affects the assets contained in a firm’s or fund’s portfolio. It can be defined as the doubt of a financial institution’s earnings which results from changes in market conditions such as the price of an asset, interest rates, market volatility and market liquidity.

Liquidity Risk
 The possibility that the cash available to a bank exceed by customer’s calls on it, or the income generated by a corporation, along with the funds raise through equity or debt issuance and/or borrowing, are insufficient to cover operating commitment forcing the corporation to stop operations. It can also be through thin markets sometimes resulting from distractions, which result in the unavailability of hedging instruments at economic prices. Most institutions generally face two types of liquidity risk, the first relates to the depth of markets for definite products and the second to funding the financial-trading activities of the firm. For example, some firms have contract limits for every futures contract based on the volume of turnover and outstanding. Senior managers have to develop methods to identify and monitor the firm’s liquidity sources to ensure it can meet the funding demands of its activities. This is achieved by examining the differences in maturities between assets and liabilities and by analyzing future funding requirements based on various assumptions, including the firm’s ability to settle down positions quickly in adverse conditions.

Credit Risk (Counterparty Risk)
 This risk may occur due to the non-payment by the borrower or counterparty such that loans, bonds or leases will not be repaid on time or in full or the counterparty will fail to perform on an obligation to the institution. The likelihood of this happening is calculated through the repayment record or default rate of the borrowing entity, determination of market conditions, and default rate of a loan portfolio of similar borrowers.

Sovereign Risk
This is the risk that a government action will interfere with repayment of a loan or security. This is measured, by the past performance of the nation and present default rate and situation such as political, social and economic. It is controlled by severe credit analysis, limiting exposure as a percentage of portfolios, and incorporating covenants into the loan documents.

Settlement Risk
This refers to the risk that an expected settlement payment on a commitment will not be made on time due to bankruptcy, inability or time zone differential and it is related to credit risk but not identical. For example, a bilateral obligation in which one party makes a required settlement payment and the counterparty does not. Settlement risk provides an important inspiration to develop netting arrangements and other safeguards and is also called Delivery Risk.

Interest Rate Risk
 The risk due to changes in interest rates results in financial losses related to asset or liability management. It is measured by past and present market instability and the...
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