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    Week 3

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    santhoshkumarp021

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    Week 3

    Uploaded by

    santhoshkumarp021
    2 views2 pages

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    © © All Rights Reserved

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    Copyright:

    © All Rights Reserved
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    Download as rtf, pdf, or txt
    2 views2 pages

    Week 3

    Uploaded by

    santhoshkumarp021

    Copyright:

    © All Rights Reserved
    Download as RTF, PDF, TXT or read online from Scribd
    Download as rtf, pdf, or txt
    of 2

    Q.

    Discuss the types of Risks, Bring out the relationship between Risks and Return
    Answer as follows

    The following are the types of risk.


    Market Risk
    This type of risk arises due to the movement in prices of financial instruments. The price of a
    financial instrument can be decreased due to market factors and sentiments. Market risk can be
    classified as Directional Risk and Non-Directional Risk. Directional risk is caused due to
    movement in stock prices, interest rates and more. Non-Directional risk, on the other hand, can
    be volatility risks.
    Credit Risk
    Credit risk is the possibility of a loss resulting from a borrower's failure to repay a loan or meet
    contractual obligations. Credit risk can be classified into Sovereign Risk and Settlement 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.
    Liquidity Risk
    Liquidity risk occurs when an individual investor, business, or financial institution fails to meet
    its short-term debt obligations due to a lack of buyers or an inefficient market The investor or
    entity might not be able to convert an asset into cash without giving up capital and income. This
    type of risk arises out of an inability to execute transactions. Liquidity risk can be classified into
    Asset Liquidity Risk and Funding Liquidity Risk. Asset Liquidity risk arises either due to
    insufficient buyers or insufficient sellers against sell orders and buys orders respectively.
    Operational Risk
    This type of risk arises out of operational failures such as mismanagement or technical failures.
    Operational risk can be classified into Fraud Risk and Model Risk. Fraud risk arises due to the
    lack of controls and Model risk arises due to incorrect model application.
    Legal Risk
    This type of financial risk arises out of legal constraints such as lawsuits. It could be a claim
    made against a financial institution, a change in the law or a failure to take the proper legal
    measures to protect themselves. Whenever a company needs to face financial losses out of legal
    proceedings, it is a legal risk.
    Funding risk
    Funding risk means uncertainty about whether investors will provide sufficient funds. It occurs
    when the investors have adequate funds for investing in an investment having a high return.
    Reputational risk
    Uncertainty about how your entity will be perceived.
    Political risk
    Political risk occurs when there is uncertainty about government actions.

    Relationship between Risks and Returns


    There is a positive relationship between risk and return. Greater risks do not guarantee higher
    returns; they can also result in the loss of the invested amount. To yield the positive effect of the
    risk and return relationship, you must figure out your risk tolerance.

    Risk tolerance can vary based on different factors. The significant factors that impact risk
    tolerance are the capability of the investor to replace the lost fund in the future and their
    retirement time. They directly impact the future earning probability. Some other factors that
    affect risk tolerance are the investor’s assets like insurance, pension plan, home, and portfolio
    size.

    The relationship between risk and return in finance is simple to understand if you know your risk
    tolerance level and can estimate the benefit or loss from returns. Exploring the different aspects
    of risk according to the stature and capacity of the subject can benefit the investors from facing
    any unexpected events in exchange for returns. The subject can benefit investors by exploring
    the meaning of risk according to their stature and capacity to face unexpected events in exchange
    for returns.

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