Financial risk is normally any risk associated with any form of financing. Risk is probability of unfavorable condition; in financial sector it is the probability of actual return being less than expected return. There will be uncertainty in every business; the level of uncertainty present is called risk.
Investment related
Depending on the nature of the investment, the type of 'investment' risk will vary. High risk investments have greater potential rewards, but also have greater potential consequences.
A common concern with any investment is that the initial amount invested may be lost (also known as "the capital"). This risk is therefore often referred to as capital risk.
If the invested assets are being held in another currency, there is a risk that currency movements alone may affect the value. This is referred to as currency risk.
Many forms of investment may not be readily salable on the open market (e.g. commercial property) or the market has a small capacity and may therefore take time to sell. Assets that are easily sold are termed liquid: therefore this type of risk is termed liquidity risk.
Business related
The risk that a company or project will not have adequate cash flow to meet financial obligations; thus causing the business to file for bankruptcy.
Financial risk is the additional risk a shareholder bears when a company uses debt in addition to equity financing. Companies that issue more debt instruments would have higher financial risk than companies financed mostly or entirely by equity.
Bilateral barter can depend upon a mutual coincidence of wants. Before any transaction can be undertaken, each party must be able to supply something the other party demands. To overcome this mutual coincidence problem, some communities had developed a system of intermediaries who can warehouse and trade goods. However, intermediaries often suffered from financial risk.
Whilst higher risk normally implies higher overall rewards, this is not always the case. For example a high risk mortgage client may be required to pay a higher interest rate on their mortgage repayments in order to be accepted as a bank's customer. However, this higher mortgage rate will in itself increase the risk to the bank that the customer cannot meet their interest payments, further increasing the risk.
This circular risk problem can lead to markets not existing for high risk borrowers. The 2007/8 sub-prime crisis may have some links to this argument. Higher interest rates for high risk borrowers make the borrowers even less likely to be able to pay back the loan, further increasing the default risk.
Credit Risk
See also: Credit risk
Insurance related
Market risk
See also: Market risk
Liquidity risk
Operational Risk
See also
