RISKS

 Risk implies future uncertainty about deviation from

expected earnings or expected outcome. Risk measures
the uncertainty that an investor is willing to take to realize a
gain from an investment.
 Risk can be referred as the chances of having an unexpected
or negative outcome. Any action or activity that leads to loss
of any type can be termed as risk.
 Risk can be defined as the chance that the expected or
prospective advantage, gain, profit or return may not
materialise; that the actual outcome of investment may be
less than the expected outcome.
TOP TEN RISK THEMES-2023
5 of the World’s Most Devastating Financial Crises

 The Credit Crisis of Europe- 1772

 The Great Depression of 1929–39--- Wall street crash & poor
policy of US.
 The OPEC Oil Price Shock of 1973– Primary concerned with
Arabian Countries.
 The Asian Crisis of 1997—Asian Tigers, originated in
Thailand
 The Financial Crisis of 2007–08– Sub- prime crisis
causes of risks in a financial system

 Weak financial institutions, inadequate regulation and

supervision, and lack of transparency have been at the heart of
global financial crises.
 These have highlighted the importance of systemic risk
monitoring and management, which is why the IMF has stepped
up efforts to help countries support sound financial systems.
 Vulnerability assessments are required by Apex banks of the
country.
detailing Causes of RISKS IN A FINANCIAL
SYSTEM
 Elevated valuation pressures are signaled by asset prices that are
high relative to economic fundamentals or historical norms and are
often driven by an increased willingness of investors to take on risk.
 Excessive borrowing by businesses and households leaves them
vulnerable to distress if their incomes decline or the assets they own
fall in value.
 In the event of such shocks, businesses and households with high
debt burdens may need to cut back spending sharply, affecting the
overall level of economic activity.
 Moreover, when businesses and households cannot make payments
on their loans, financial institutions and investors incur losses.
 Excessive leverage within the financial sector increases the
risk that financial institutions will not have the sufficient capacity
to absorb losses when hit by adverse shocks.
 In those situations, institutions will be forced to cut back lending,
sell their assets, or, in extreme cases, shut down.
 Such responses can substantially impair credit access for
households and businesses.
 Elevated funding risks can occur when financial institutions
raise funds from the public with a commitment to return investor
money on short notice, but those institutions then invest much of
the funds in illiquid assets that are hard to sell quickly or in assets
that have a long maturity.
 This liquidity and maturity transformation can create an incentive
for investors to withdraw funds quickly in adverse situations,
commonly referred to as a “run.
IMPACT OF RISKS

 When financial crises occur, they can have far-reaching

effects. They can deepen economic downturns, trigger capital
flight, and lower exchange rates.
 They can disrupt financial intermediation and undermine
monetary policy.
 They can have large fiscal costs that come from rescuing
troubled financial institutions.
 As financial institutions and countries are increasingly connected,
financial shocks in one area can quickly spill across financial
sectors and national borders.
 That makes resilient, well-regulated, and well-supervised
financial systems essential for economic and financial stability.
 IMF as the monitoring authority for its member countries
analyses, also point to crucial links between financial stability,
financial depth, and financial inclusion.
 RISK RETURN TRADE OFF
The risk-return trade-off helps you to quantify the units of risk you are willing to take for
every unit of return.
 Higher returns entails higher risk but higher risk does not
necessarily mean higher returns.
 For example, you can take a very high risk by putting all your
money in a commodity fund. But if the commodity goes through
a prolonged multi-year bear cycle then your portfolio will grossly
underperform and give negative returns although you have taken
on higher risk.
 Hence you should only take on calibrated and measured risk.

Traditional theory gives way & the Optimal theory comes into
picture.
 Systematic risk, also known as "market risk" or "un-diversifiable risk",
is the uncertainty inherent to the entire market or entire market
segment. Theses risks can affect an entire economic market overall or
a large percentage of the total market
 Market risk is the risk of losing investments due to factors, such
as political risk and macroeconomic risk, that affect the performance
of the overall market.
 Market risk cannot be easily mitigated through portfolio diversification.
 Other common types of systematic risk can include interest rate risk,
inflation risk, currency risk, liquidity risk, country risk, and
sociopolitical risk
 Unsystematic risk, also known as "specific risk," "diversifiable
risk" or "residual risk," is the type of uncertainty that comes with
the company or industry you invest in. Unsystematic risk can be
reduced through diversification.
 For example, news that is specific to a small number of stocks,
such as a sudden strike by the employees of a company you have
shares in, is considered to be unsystematic risk.
 A new competitor in the marketplace with the potential to take
away market share from a company, a change in management, a
product recall, a regulatory change that could drive down
company sales.
 TYPES OF RISKS

 Business Risk: These types of risks are taken by business

enterprises themselves in order to maximize shareholder value
and profits. As for example: Companies undertake high cost risks
in marketing to launch new product in order to gain higher sales.-
UNSYSTEMATIC RISK
 Non- Business Risk: These types of risks are not under the
control of firms. Risks that arise out of political and economic
imbalances can be termed as non-business risk.- SYSTEMATIC
RISK
FINDINGS OF RESEARCH FROM 13 COUNTRIES &
10 INDUSTRIES
 FINANCIAL RISK
 Financial Risk: as the term suggests is the risk that involves
financial loss to firms. When the company is highly leveraged
financial risks come into picture in corporates.
 Financial risk generally arises due to instability and losses in the
financial market caused by movements in stock prices,
currencies, interest rates and more.
 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.
 TYPES OF RISKS

 Market Risk: This type of risk arises due to movement in prices

of financial instrument. Market risk can be classified as
Directional Risk and Non - 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 fulfil their
obligations towards their counter parties. 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 fulfil the obligations.
 Liquidity Risk: This type of risk arises out of 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 buy orders respectively.
 Liquidity risk refers to the situation wherein it may not be possible
to dispose off or sell the asset or it may be possible to do so only at
great inconvenience, and cost in terms of time and money. The
greater the uncertainty about time element, price concession,
transaction cost, greater the liquidity risk.
 Default risk arises from the failure on the part of the borrower
or debtors to pay the specified amount of interest and/ or t o repay
the principal, both at the time specified in the debt contract or
indenture.
 Maturity risk arises when the term of maturity of the security
happens to be longer. Long term investment involves risk.
 Operational Risk: This type of risk arises out of operational
failures such as mismanagement or technical failures.
 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.
 Call risk is associated with corporate bonds which are issued
with a call back provision whereby the issuer has the right to
redeem the bonds before maturity. Reinvesting it would be at a
lower interest.
 Interest rate risk is the variability in return of security due to the
changes in the level of market interest rates or is the loss of
principal of a fixed return security due to increase in the general
level of interest. When interest rise the value or market price of
the security drops and vice versa. The degree of interest rate risk
is directly related to the length of time to maturity of the security

 Inflation risk also known as purchasing power risk, is the risk
that the real return on the security may be less than the nominal
return. In case of fixed income securities, since payment in terms
of rupees are fixed, the value of the payments in real term
declines as the level of commodity prices increases.
 Exchange rate or currency risk refers to cash flow variability
experienced by economic units engaged in international
transactions or international exchange on account of uncertain or
unexpected changes in exchange rates.
 Business risk is the uncertainty of income flows that is called by
the nature of a firm’s business i.e. by doing business in a
particular environment. It has 2 components— Operational risks
and operational efficiency.
FOREIGN EXCHANGE EXPOSURES
 Foreign exchange exposure is something that anyone who
transacts or does business in more than one currency should be
aware of.
 In short, forex exposure refers to the risk that a company
takes on when making transactions in foreign currencies.
 If a business is looking to transact across multiple currencies, it’s
important that they first identify their exposure to risk in order to
put a calculated risk management strategy in place.
 Foreign exchange risk refers to the risk that a business’
financial performance or financial position will be affected by
changes in the exchange rates between currencies.
 Foreign exchange risk can be caused by appreciation/depreciation
of the base currency, appreciation/depreciation of the foreign
currency, or a combination of the two.
 It is a major risk to consider for exporters/importers and
businesses that trade in international markets.
 FX is unpredictable. Movements are like huge waves. Sometimes
they’re huge, other times they’re small. If you can’t ride them,
you’re dead. It’s decentralized & ( large) colossal market.
 RISK STRUCTURE
 Foreign exchange risk, also known as exchange rate risk, is the
risk of financial impact due to exchange rate fluctuations.
 Foreign exchange risk is the risk that a business’ financial
performance or financial position will be impacted by changes in
the exchange rates between currencies.
TRANSACTION EXPOSURE
 Transaction exposure is considered a “short-run” type of forex
exposure.
 It refers to the risk that is taken on when carrying out a transaction
involving foreign currency.
 If the currencies being transacted rises or fall in an unfavourable
direction, it can negatively impact financially and this is the nature of
transactional risk.
 In simple words transacting in different currencies and exposing to
potential loss in the face of fluctuation.
 As most business transactions have the ultimate goal of turning a
profit, this type of exposure can impact the bottom line if dealings are
in large-volume transactions and particularly volatile currencies.
 Transaction risk is the risk faced by a company when making
financial transactions between jurisdictions. The risk is the
change in the exchange rate before transaction settlement.
 The time delay between transaction and settlement is the
source of transaction risk.
 Transaction risk can be mitigated using forward contracts
and options.
 As most business transactions have the ultimate goal of turning a
profit, this type of exposure can impact your bottom line if you
are dealing with large-volume transactions and particularly
volatile currencies.
TRANSLATION RISK
 Translation risk, also known as translation exposure, refers to the
risk faced by a company headquartered domestically but
conducting business in a foreign jurisdiction, and of which the
company’s financial performance is denoted in its domestic
currency.
 Translation risk is higher when a company holds a greater
portion of its assets, liabilities, or equities in a foreign
currency.
 For example, a parent company that reports in Canadian dollars
but oversees a subsidiary based in China faces translation risk, as
the subsidiary’s financial performance – which is in Chinese yuan
– is translated into Canadian dollar for reporting purposes.
 ECONOMIC RISK

 Economic risk, also known as forecast risk, is the risk that a

company’s market value is impacted by unavoidable exposure to
exchange rate fluctuations.
 Such a type of risk is usually created by macroeconomic
conditions such as geopolitical instability and/or government
regulations.
 Ukraine & Russia war
 CASE STUDY 1
 Company A, based in Canada, recently entered into an agreement
to purchase 10 advanced pieces of machinery from Company B,
which is based in Europe. The price per machinery is €10,000,
and the exchange rate between the euro (€) and the Canadian
dollar ($) is 1:1.
 A week later, when Company A commits to purchasing the 10
pieces of machinery, the exchange rate between the euro and
Canadian dollar changes to 1:1.2.
 What type of risk is the company facing? Is it an example of
transaction risk, economic risk, or translation risk?
 CASE STUDY -2
 Company A, based in Canada, reports its financial statements in
Canadian dollars but conducts business in U.S. dollars. In other
words, the company makes financial transactions in United States
dollars but reports in Canadian dollars. The exchange rate
between the Canadian dollar and the US dollar was 1:1 when the
company reported its Q1 financial results.
 However, it is now 1:1.2 when the company reported its Q2
financial results.
 Is it an example of transaction risk, economic risk, or translation
risk?
 TRANSACTION RISK EXAMPLE
 Forexample, a Canadian company with operations in
China is looking to transfer CNY600 in earnings to its
Canadian account.
 Ifthe exchange rate at the time of the transaction was 1
CAD for 6 CNY, and the rate subsequently falls to 1
CAD for 7 CNY before settlement, an expected receipt
of CAD100 (CNY600/6) would instead of CAD86
(CNY600/7).
 Interest Rate Risk
Interest rates affect exchange. If the interest rate of a country is high, the
currency strengthens. If the interest rate is low, the currency weakens.
 Country Risk
A currency risk can occur as a result of frequent balance of payment
deficits. This typically results to the devaluation of a currency. Before you
invest in a country, make sure to assess the structure and stability of that
country.
 Counterparty Risk
The counterparty is the company that provides the asset to you. This
means, this is the risk of default from a dealer or broker in a certain
transaction.
 Leverage Risk
In forex trading, a small initial investment known as a margin is
necessary for conducting substantial foreign currency trades. Due to
slight fluctuations in price resulting in margin calls, the investor
may have to pay an additional sum as margin. When the market is
volatile, using leverage very aggressively may lead to considerable
losses through initial investments.
 Country Risk
In multiple developing nations, the currency exchange rates depend
on a leading currency, such as the USD
 In order to ensure that the exchange rate is maintained, the
developing country’s central bank must have sufficient reserves.
If there are frequent deficits in payment, the developing country’s
currency may face significant devaluation.
 This in turn affects prices in the forex market. It can also prompt
investors to withdraw to avoid losses in anticipation of a currency
crisis.
 Geopolitical risk, also known as political risk, transpires when a
country's government unexpectedly changes its policies,
which now negatively affect the foreign company.
 These policy changes can include such things as trade barriers,
which serve to limit or prevent international trade.
 These include taxes, spending, regulation, currency valuation,
trade tariffs, labor laws such as the minimum wage, and
environmental regulations.
Risk analytics
 Risk analytics is a set of techniques that measures, quantifies,
and predicts risk with a large degree of accuracy.
 There are two main risk analysis methods. The easier and more
convenient method is qualitative risk analysis. Qualitative risk
analysis rates or scores risk based on the perception of the
severity and likelihood of its consequences. Quantitative risk
analysis, on the other hand, calculates risk based on available
data.
 For qualitative risk analysis, this is projected risk, which is an
estimation or guess of how the risk will manifest. Quantitative
risk analysis deals with statistical risk. Unlike projected risk,
statistical risk is specific and verified.
READING---CLASS ROOM

 https://www.dnb.com/perspectives/finance-credit-risk/quarterly-global-busi
ness-risk-report.html
 https://www.youtube.com/watch?v=GUPz_zARKpk
 LINKS--- FOR CLASS ROOM
 https://www.youtube.com/watch?v=Fcw1-Olmi_s
 https://www.youtube.com/watch?v=JqfNc_zTiwQ&list=RDCMUC2XO4HDxzfMOZI
V1l795g1Q&index=1
 https://www.youtube.com/watch?v=sbL6z7vS-hg---TO C IN STOCK MARKET

 https://www.youtube.com/watch?v=xXaS3AZSbeQ----CAPITAL MARKET RISK

 https://www.youtube.com/watch?v=BOn4ry5XNtQ---more technical ( last to be shown)