Easy Explanation Notes with Examples

Financial Risk

A probability of gain or loss in the investment is called financial risk.  There are many types of financial risk and most common are the credit risk, political risk, interest rate risk and currency risk.

Credit Risk

When a lender made payment to a borrower, there is always an element of risk that borrower may not pay back to the lender. This element of risk is called credit risk and it can never be eliminated. It can be transferred to the third party by insurance or mitigated by methods like strong checks on credit control and debt collection activities like aging analysis of debtors. For example, you made credit sale of $ 500 and you are not sure whether you will get your money back or not. Although that type of risk can not be eliminated. However, you can minimize it by having strong credit checks like the sale to reliable clients and send them debt reminder or you can transfer that risk by having insurance or debt factoring.

Political Risk

It is a probability that political decisions, events, and conditions may significantly affect the profitability of businesses in local or foreign countries. It can take different shapes and might be financial and non-financial like confiscation of company assets, restriction on converting currency and restricted access to local borrowings etc. One can not prevent political risk but is can be minimized by evaluating country macroeconomic factors, current government popularity and using political ranking tables etc.

Interest Rate Risk

It is a possibility that a company with receivable or payable may get loss or income due to interest rate rise or decrease in future. It can be minimized by using different interest rate hedge techniques.

Currency Risk

Currency risk arises from possible movements in an exchange rate and it can move either in favor or adverse. It affects an organization with assets or liabilities in foreign currency or income or expenditures in foreign currency. It can further categorize as economic, transaction and translation exposure risk.

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