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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.


Market Risk:
This type of risk arises due to movement in prices of financial instrument. Market
risk can be classified asDirectional RiskandNon - 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.

Credit Risk:
This type of risk arises when one fails to fulfill their obligations towards their
counter parties.Credit riskcan be classified intoSovereign RiskandSettlement
Risk. Sovereign risk usually arises due to difficult foreign exchange policies.
Settlement risk on the other hand arises when one party makes the payment while
the other party fails to fulfill the obligations.
A consumer may fail to make a payment due on a mortgage loan, credit
card, line of credit, or other loan.

Liquidity Risk:
This type of risk arises out of inability to execute transactions. Liquidity risk can be classified
intoAsset Liquidity RiskandFunding Liquidity Risk. Asset Liquidity risk arises either due to
insufficient buyers or insufficient sellers against sell orders and buy orders respectively.
Operational Risk:
This type of risk arises out of operational failures such as mismanagement or technical
failures. Operational risk can be classified intoFraud RiskandModel Risk. Fraud risk arises
due to lack of controls and Model risk arises due to incorrect model application.
computer hacking, internal and external fraud, the failure to adhere to internal
policies, and others.
Legal Risk:
This type of financial risk arises out of legal constraints such as lawsuits. Whenever a
company needs to face financial loses out of legal proceedings, it is legal risk.


Alpha: Measures risk relative to the market or benchmark index

Beta: Measures volatility orsystemic riskcompared to the market or the

benchmark index

R-Squared: Measures the percentage of an investment's movement that are

attributable to movements in its benchmark index

Standard Deviation: Measures how much return on an investment is deviating

from the expected normal or average returns

Sharpe Ratio: An indicator of whether an investment's return is due to

smartinvestingdecisions or a result of excess risk.

Risk management is the process of identification,
analysis and either acceptance or mitigation of
uncertainty in investment decision-making.
Essentially, risk management occurs anytime an
investor orfund manageranalyses and attempts to
quantify the potential for losses in an investment and
then takes the appropriate action (or inaction) given
theirinvestment objectivesandrisk tolerance.


A derivative is a security with a price that is

dependent upon or derived from one or more
underlying assets. The derivative itself is a contract
between two or more parties based upon the asset
or assets. Its value is determined by fluctuations in
the underlying asset. The most common underlying
assets include stocks, bonds, commodities,
currencies, interest rates and market indexes.


An option is a financial derivative that represents a contract sold by one

party (option writer) to another party (option holder). The contract offers
the buyer the right, but not the obligation, to buy (call) or sell (put) a
security or other financial asset at an agreed-upon price (the strike
price) during a certain period of time or on a specific date (exercise

Call options give the option to buy at certain price, so the buyer would
want the stock to go up.

Put options give the option to sell at a certain price, so the buyer would
want the stock to go down.


Futures are financial contracts obligating the buyer to

purchase an asset (or the seller to sell an asset), such
as a physical commodity or a financial instrument, at a
predetermined future date and price. Futures contracts
detail the quality and quantity of the underlying asset;
they are standardized to facilitate trading on a futures
exchange. Some futures contracts may call for
physical delivery of the asset, while others are settled
in cash. The futures markets are characterized by the
ability to use very high leverage relative to stock


A swap is a derivative contract through which two parties

exchange financial instruments. These instruments can be
almost anything, but most swaps involve cash flows based on
a notional principal amount that both parties agree to.
Usually, the principal does not change hands. Each cash flow
comprises one leg of the swap. One cash flow is generally
fixed, while the other is variable, that is, based on a
benchmark interest rate, floating currency exchange rate or
index price.


A credit default swap is a particular type of swap

designed to transfer the credit exposure of fixed
income products between two or more parties. In a
credit default swap, the buyer of the swap makes
payments to the swaps seller up until the maturity
date of a contract. In return, the seller agrees that,
in the event that the debt issuer defaults or
experiences another credit event, the seller will pay
the buyer the securitys premium as well all interest
payments that would have been paid between that
time and the securitys maturity date.