Types of Financial Risks:
Financial risk is one of the high-priority risk types for every business. Financial risk is caused due to market movements and market movements can include host of factors. Based on this, financial risk can be classified into various types such as Market Risk, Credit Risk, Liquidity Risk, Operational Risk and Legal Risk.
This type of risk arises due to 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 has traditionally been measured through the beta coefficient of the Capital Asset Pricing Model. This coefficient represents the variability of asset (or portfolio) returns as they relate to the market There are four major types of market risk:
Interest Rate Risk
Equity Price Risk
Foreign Exchange Risk
Commodity Price Risk
Interest Rate Risk
Interest rate risk is the risk that the value of a security will fall as a result of increase in interest rates. However, in complex portfolios, many different types of exposures can arise. Basis risk: Banks can face basis risk if the interest-bearing assets and liabilities have different bases such as the London Interbank Offered Rate (LIBOR) versus the U.S. prime rate. In some circumstances different bases will move at different rates or in different directions, which can cause erratic changes in revenues and expenses. Re-pricing risk: Banks can also face re-pricing risk, that is, the risk presented by assets and liabilities that re-price at different times and rates. For instance, a loan with a variable rate will generate more interest income when rates rise and less interest income when rates fall. If the loan is funded with fixed rated deposits, the bank’s interest margin will fluctuate. Yield curve risk: Yield curve risk is presented by...
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