Definition Types Of Risk In Finance
Almost everyone is familiar with the term risk, which means uncertainty or downsides related to any work.
However, when it is about risk in finance, the meaning is a bit different.
If you are interested in making financial transactions in business or in the stock market, it is important for you to know what is the definition of risk in finance.
Risk in finance or financial risk is a broad term used to indicate the different types of downsides related to financing, including loans that may turn to defaults. It generally hints toward the probability in which the actual return on an investment might be lower than the expected sum.
The return may at times fall below the principal amount.
Types of risks
Depending on the types of financial transactions, the risks are divided into the following categories:
Asset-backed risk- Prepayment risk, term modification, and interest rate are generally classified as asset-backed risk.
This type of risk varies in one or more than one assets, providing an asset-backed security.
This type of risks mostly affects supported security’s value.
Credit risk- Also known as the default risk, it is generally associated with the borrowers, who fails to make payments on time and turn to default.
In this types of risks, investors may lose the expected interest rate and at times even the principal amount. Apart from that, a steep rise in the collection cost and a reduction in the flow of cash is also associated with these types of risks.
Credit risk can be assumed in indirect or direct leverages.
Foreign investment risk- As the name indicates, this type of risk mostly impacts the foreign investment market or the foreign exchange market.
There are several factors associated with this type of risk, viz. differing accounting, smaller markets, auditing standards, reporting, nationalization, confiscatory taxation or evaporation, diplomatic or political changes and economic conflicts.
Regulatory issues, liquidity, valuation may also make an impact on foreign investment risk.
Liquidity risk- This type of risk generally indicates that it will not be possible to trade or sell a particular type of asset or security easily in the market for dealing with the losses
Liquidity risk is further divided into asset liquidity and funding liquidity.