Types of risks

Размещено на http://www.allbest.ru/

FINANCIAL UNIVERSITY UNDER THE GOVERNMENT OF THE RUSSIAN FEDERATION

Faculty of Management

Course Paper

“Types of risks”

Student: A. Nguen

Checked by: N.A. Gazova

Moscow, 2014

CONTENTS

INTRODUCTION

1. CLASSIFICATION OF RISK TYPES

2. HOW TO REDUCE FINANCIAL RISKS

CONCLUSION

BIBLIOGRAPHY

INTRODUCTION

In today's globally interdependent market place, risks to businesses are no longer isolated by industry or location. They are becoming more complex and harder to predict. Even the most seasoned risk managers find it a challenge to anticipate and respond effectively to the increasingly expansive and evolving threats to their businesses. Managing and mitigating risk is a necessity for survival, but not all risks are as insurable as transoceanic cargo or natural disasters. Here are the unpredictable ones that organizations fear most.

So risks is the possibility that a company will have lower than anticipated profits, or that it will experience a loss rather than a profit. Business risk is influenced by numerous factors, including sales volume, per-unit price, input costs, competition, overall economic climate and government regulations.

The main objective of this work is to classify different types of risks.

In order to achieve this goal I set and should solve the following tasks:

1. Study the concepts of marketing and advertising

2. Identify the steps of reducing risks

1. CLASSIFICATION OF RISK TYPES

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. There are different types of risks that a firm might face and needs to overcome. Risks may be broadly classified into two types, depending upon their place of origin.

§ Internal risks are those risks which arise from the events taking place within the business enterprise. Such risks arise during the ordinary course of a business. These risks can be forecasted and the probability of their occurrence can be determined. Hence, they can be controlled by the entrepreneur to an appreciable extent.

The various internal factors giving rise to such risks are:

1. Human factors are an important cause of internal risks. They may result from strikes and lock-outs by trade unions; negligence and dishonesty of an employee; accidents or deaths in the industry; incompetence of the manager or other important people in the organisation, etc. Also, failure of suppliers to supply the materials or goods on time or default in payment by debtors may adversely affect the business enterprise.

2. Technological factors are the unforeseen changes in the techniques of production or distribution. They may result in technological obsolescence and other business risks. For example, if there is some technological advancement which results in products of higher quality, then a firm which is using the traditional technique of production might face the risk of losing the market for its inferior quality product.

3. Physical factors are the factors which result in loss or damage to the property of the firm. They include the failure of machinery and equipment used in business; fire or theft in the industry; damages in transit of goods, etc. It also includes losses to the firm arising from the compensation paid by the firm to the third parties on account of intentional or unintentional damages caused to them.

§ External risks are those risks which arise due to the events occurring outside the business organisation. Such events are generally beyond the control of an entrepreneur. Hence, the resulting risks cannot be forecasted and the probability of their occurrence cannot be determined with accuracy.

The various external factors which may give rise to such risks are :

1. Economic factors are the most important causes of external risks. They result from the changes in the prevailing market conditions. They may be in the form of changes in demand for the product, price fluctuations, changes in tastes and preferences of the consumers and changes in income, output or trade cycles. The conditions like increased competition for the product, inflationary tendency in the economy, rising unemployment as well as the fluctuations in world economy may also adversely affect the business enterprise. Such risks which are caused by changes in the economy are known as 'dynamic risks'. These risks are generally less predictable because they do not appear at regular intervals. Also, such risks may not necessarily result in losses to the firm because they may also contain an element of gain for the firm. For instance, due to market fluctuations, a well known product of a firm may either lose its demand or may occupy a larger market share.

2. Natural factors are the unforeseen natural calamities over which an entrepreneur has very little or no control. They result from events like earthquake, flood, famine, cyclone, lightening, tornado, etc. Such events may cause loss of life and property to the firm or they may spoil its goods. For example, Gujarat earthquake caused irreparable damage not only to the business enterprises but also adversely affected the whole economy of the State.

3. Political factors have an important influence on the functioning of a business, both in the long and short term. They result from political changes in a country like fall or change in the Government, communal violence or riots in the country, civil war as well as hostilities with the neighbouring countries. Besides, changes in Government policies and regulations may also affect the profitability and position of a enterprise. For instance, changes in industrial policy and Trade policy annual announcement of the budget amendments to various legislations, etc. may enhance or reduce the profits of a business enterprise.

There is another classification of risk and widely, they can be classified into three types: Business Risk, Non-Business Risk and Financial Risk

1. 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.

2. 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.

3. Financial Risk: Financial Risk as the term suggests is the risk that involves financial loss to firms. Financial risk generally arises due to instability and losses in the financial market caused by movements in stock prices, currencies, interest rates and more.

Different types of risks can be classified under two main groups:

A) Systematic risk is uncontrollable by an organization and macro in nature and is due to the influence of external factors on an organization. It is a macro in nature as it affects a large number of organizations operating under a similar stream or same domain. It cannot be planned by the organization.

a. Interest rate risk arises due to variability in the interest rates from time to time. It particularly affects debt securities as they carry the fixed rate of interest. Economic conditions cause interest rate risk. When the Federal Reserve decides that the economy has overheated to a point that inflation is a risk, it will institute restrictive monetary policy. This consists of removing money from the system and raising interest rates. Higher interest rates cause the market price of bonds to decline. When the economy is in recession, the Fed will institute expansionary monetary policy, adding money to the system and lowering interest rates. This form of interest rate risk primarily affects banks because they get the money they loan out through certificates of deposit and savings accounts. If they write one-year CDs at 8 percent and interest rates drop quickly, they may be lending that money out at 6 percent and losing money until the CDs mature and they can replace those deposits at 4 percent or lower with new CDs. Inflation risk is a function of Fed monetary policy and can also be considered part of interest rate risk.

There are two types of interest rate risks: price risk (arises due to the possibility that the price of the shares, commodity, investment, etc. may decline or fall in the future); reinvestment rate risk (results from fact that the interest or dividend earned from an investment can't be reinvested with the same rate of return as it was acquiring earlier).

b. Market risk is associated with consistent fluctuations seen in the trading price of any particular shares or securities. That is, it arises due to rise or fall in the trading price of listed shares or securities in the stock market. A catastrophic event that causes a market reaction, either up or down, is one example of market risk. Changes in Fed policy, changes in the economy as evidenced in the monthly publication of various economic indicator statistics, surprising earnings reports from major companies that indicate weakness in key industries and normal market consolidations are all market risks. They affect the price of investments and, depending on whether you own stock or bonds, are net short (sold without owning in anticipation of a drop in the market price) or long (own in anticipation of a rise in the market price) your investments, you can expect to experience market risk.

c. Purchasing power or inflationary risk is also known as inflation risk. It is so, since it emanates (originates) from the fact that it affects a purchasing power adversely. It is not desirable to invest in securities during an inflationary period.

There two types of inflationary risk: demand inflation risk (arises due to increase in price, which result from an excess of demand over supply. It occurs when supply fails to cope with the demand and hence cannot expand anymore. In other words, demand inflation occurs when production factors are under maximum utilization); cost inflation risk arises due to sustained increase in the prices of goods and services. It is actually caused by higher production cost. A high cost of production inflates the final price of finished goods consumed by people.

B) Unsystematic risk is controllable by an organization and micro in nature, is due to the influence of internal factors prevailing within an organization. It is a micro in nature as it affects only a particular organization. It can be planned, so that necessary actions can be taken by the organization to mitigate (reduce the effect of the risk.

a. Business or liquidity risk is also known as liquidity risk. It is so, since it emanates (originates) from the sale and purchase of securities affected by business cycles, technological changes, etc. Some investments, such as private purchases of non-trading stock, are not liquid - they cannot easily be sold. Other investments, such as very small issues of publicly trading stock, are not easy to sell because the stock does not trade on a daily basis because not many people are interested in buying it. Other instances of illiquidity happen when a company is rumored to be on the verge of bankruptcy, experiences a drastic event or trading is halted because of imbalance between the volume of shares for sale and the volume of purchase orders. Liquidity risk affects your ability to quickly sell your securities and may affect the price you receive.

b. Financial risk is also known as credit risk. It arises due to change in the capital structure of the organization. Also credit risk is referred to as the possibility that an investment will lose value owing to declining financial strength in the underlying company Default risk is one component, referring to the potential for a financially weakened company to default on its payments of interest and principal to bond holders and an eventual collapse of the enterprise, which makes the stock worthless. High credit risk, whether in terms of securities investments or consumer and corporate loans, leads to high interest rates to compensate for the potential of late payments or total default.

c. Operational risks are the business process risks failing due to human errors. This risk will change from industry to industry. It occurs due to breakdowns in the internal procedures, people, policies and systems.

There are several types of operational risks: model risk (is involved in using various models to value financial securities. It is due to probability of loss resulting from the weaknesses in the financial-model used in assessing and managing a risk); people risk (arises when people do not follow the organization's procedures, practices and/or rules. That is, they deviate from their expected behavior); legal risk (arises when parties are not lawfully competent to enter an agreement among themselves. Furthermore, this relates to the regulatory-risk, where a transaction could conflict with a government policy or particular legislation (law) might be amended in the future with retrospective effect); political risk (occurs due to changes in government policies. Such changes may have an unfavorable impact on an investor. It is especially prevalent in the third-world countries).

2. HOW TO REDUCE FINANCIAL RISKS

Investing, by its very nature, carries with it in interest rates, inflation rates, currency exchange rates, and managerial differences between companies, the risk that an investment will lose you money or that it will grow much more slowly than expected. To reduce financial risk to yourself, you must learn how to manage your investment portfolio well. There are several techniques involved in effective portfolio management.

1. Familiarize yourself with the different types of risk. Most financial risk can be categorized as either systematic or non-systematic. Systematic risk affects an entire economy and all of the businesses within it; an example of systematic risk would be losses due to a recession. Non-systematic risks are those that vary between companies or industries; these risks can be avoided completely through careful planning. There are several types of systematic risk. Interest risk is the risk that changing interest rates will make your current investment's rate look unfavorable. Inflation risk is the risk that inflation will increase, making your current investment's return smaller in relation. Liquidity risk is associated with "tying up" your money in long-term assets that cannot be sold easily. There are also different types of non-systematic risk. Management risk is the risk that bad management decisions will hurt a company in which you're invested. Credit risk is the risk that a debt instrument issuer (such as a bond issuer) will default on their repayments to you.

2. Determine the level of risk associated with your varied investments. Before reducing risk, you must understand how much risk you can expect from each type of investment.

· Stocks are some of the riskiest investments, but can also provide the highest return. Stocks carry no guarantee of repayment, and changing investor confidence can create market volatility, driving stock values down.

· Bonds are less risky than stocks. Because they are debt instruments, repayment is guaranteed. The risk level of a bond is therefore dependent on the credit worthiness of the issuer; a company with shakier credit is more likely to default on a bond repayment.

· Cash-equivalent investments, such as money market accounts, savings accounts, or government bonds are the least risky. These investments are also highly liquid, but they provide low returns.

3. Determine the level of risk you are willing to shoulder. When deciding on an overall level of risk, you need to assess how you want to use the money from your investments in the future.

· If you are planning a big expenditure in the near future (such as a house or tuition), or you are retiring soon, you should aim for a relatively low-risk portfolio. This will help ensure that market volatility doesn't cause your investments to lose a lot of value just before you need to draw money from them.

· If you are younger and investing for a long-term goal, more risk is appropriate. Long-term goals allow you to wait out stock price fluctuations and realize high returns over the long run.

4. Reduce your portfolio's risk level by allocating assets widely. The first key to lowering risk is to allocate your money between different investment classes. Your portfolio should include stocks, bonds, cash equivalents, and possibly other investments such as real estate. The proportion of these allocations will depend on the level of risk you want to shoulder overall.

· Allocating assets widely hedges against the risk that certain asset classes will perform well while others perform poorly. For example, if many investors begin buying corporate stocks, stock prices will rise; however, those investors may be selling bonds to fund their stock purchases, causing bond prices to fall. Spreading investments between stocks and bonds will protect against the risk of either category performing poorly.

5. Lower each asset type's risk through diversification. Diversifying your portfolio means buying a single type of asset from many different companies. This hedges against the risk that a single company or industry will perform poorly or go bankrupt.

· For example, if you buy stocks in 30 different companies, it is not likely that all 30 will perform poorly or go bankrupt at once, barring an economy-wide downturn. However, if you used the same amount of money to invest in only 1 company's stock, the company may perform poorly and drag your entire stock portfolio down with it.

CONCLUSION

The term business risk refers to the possibility of inadequate profits or even losses due to uncertainties e.g., changes in tastes, preferences of consumers, strikes, increased competition, change in government policy, obsolence etc .Every business organization contains various risk elements while doing the business.

While business risks are abound, and their consequences can be destructive, there are ways and means to insure against them, to prevent them and to minimize their damage if and when they occur. Finally, hiring a risk management consultant may be a prudent step in the prevention and management of risks.

In order to face such risks successfully, every businessman should understand the nature and causes of these risks as well as the various measures which must be taken in order to minimize them.

financial risk management

BIBLIOGRAPHY

1. Daryl Urbanski. Business success secrets, principles, formulas & ethos: your primitive business guide to giving your business the greatest chance of success, 2013

2. Sanjay Sharma. Risk transparency, 2013

3. Adam Jolly. Managing business risk , 2003

4. http://kalyan-city.blogspot.com

5. http://www.ehow.com

6. http://www.wikihow.com

Размещено на Allbest.ru