types of risk-2

8/3/2019 Types of Risk-2

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` Various types of risks Market Risk

` Beta measurement, Liquidity Risk

` Interest rate Risk- GAP analysis, Duration

` Value at risk, Forex Risk- operating exposure,Credit Risk

` Operational Risk- operating and financial leverage

` Capital and Reputation Risk


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` Broadly total risk (Variance of return) with investment isdivided in two parts i.e. systematic risk andunsystematic risk. Systematic risks affect the market

as a whole and can not be eliminated totally by anymeans. Though, it can be minimized by properdiversification and by having defensive stocks in theportfolio. (Defensive stocks are the stocks which is

having a Beta of less than 1) Unsystematic risk affectsonly a specific firm and can be eliminated totally byproper diversification.

`


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` A systematic riskis any risk that affects a large numberof assets, each to a greater or lesser degree.

` An unsystematic riskis a risk that specifically affects asingle asset or small group of assets.

` Unsystematic risk can be diversified away.

` Examples of systematic risk include uncertainty aboutgeneral economic conditions, such as GNP, interestrates or inflation.

` On the other hand, announcements specific to acompany, such as a gold mining company striking gold,are examples of unsystematic risk.


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Risk: Systematic and UnsystematicRisk: Systematic and Unsystematic

Systematic Risk; m

Nonsystematic Risk; I

n

W

Total risk;

U

We can break down the risk, U, of holding a stock into twocomponents: systematic risk and unsystematic risk:

I


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` The beta coefficient, F, tells us the response of thestocks return to a systematic risk.

` In the CAPM, F measured the responsiveness of asecuritys return to a specific risk factor, the return on themarket portfolio.

Systematic Risk and BetasSystematic Risk and Betas


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Systematic Risk and BetasSystematic Risk and Betas

)(

)(2

,

M

Mi

i

R

RRCov

W

F !

The beta coefficient, F, tells us the response of the

stocks return to a systematic risk.

In the CAPM, F measured the responsiveness of a

securitys return to a specific risk factor, the return onthe market portfolio.


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` Country Risk: This risks arises in case of allinvestment in a single country. Any change inpolitical and economic situation of the country may

impact the return.` Market risk:-It is the risk of decreasing the capital

(or suffering of loss) because of negativesentiments in the market.


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` Financial Risk: This kind of risk arises due topattern of financing mix used by the company.More debt financing will bring more risk. Company

with lesser debt or no debt will have less risk.` Liquidity Risk: This risk arises when the

investors are unable to exit from the investment atfair value at the desired date.

unsystematic risksunsystematic risks


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` Asset-Class Risk : This risk arises when assets allocation isnot done properly for the different asset classes.

` Business Risk: The risk which is associated with the nature ofbusiness. Such as, Risks associated with the change of raw

material, finished goods price, change in tax law, change inoperating costs, riot or lay off etc.

` Sector Risk: It is a risk faced by the investors whoinvest in sectoral funds or who are more inclined

towards a particular sector.


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Portfolio Risk

Risk arising from lending to sectors non relatedto the core competencies of the Bank /concentrated credits to a particular sector /lending to a few big borrowers.


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Interest Rate Risk: Risk felt, when changes in theinterest rate structure put pressure on the net interest marginof the Bank.

Interest rate fluctuation also affects the market and thereby

returns. When inerest rate increases, fixed income securitiesbecomes cheap and more attractive resulting the fall of priceof stock.

Inflation risk: Risk arises due to general price rise anddecrease in purchasing power of money.


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FOREX RISK: This risk occurs when your homecurrency appreciates or depreciates in comparison toforeign currency.This risk can be classified into three types.Transaction Risk is observed when movements inprice of a currency upwards or downwards, result in aloss on a particular transaction.Translation Risk arises due to adverse exchangerate movements and change in the level of investments and borrowings in foreign currency.

Sovereign Risk. The buyers are unable to meet thecommitment due to restrictions imposed on transfer offunds by the foreign govt. or regulators. When thetransactions are with the foreign govt.


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Operational Risk arises as a result of failure of operating system in the Company due to certainreasons like fraudulent activities, natural disaster,human error, omission or sabotage etc.Systemic Risk is seen when the failure of onefinancial institution spreads as chain reaction to

threaten the financial stability of the financial systemas a whole.Political Risk arises due to introduction of Servicetax or increase in income tax, freezing the assets ofthe Company by the legal authority etc.Human Risk Labour unrest, lack of motivation,inadequate skills, problems faced by the bank afterimplementation of VRS lead to Human Risk.Technology Risk Obsolescence, mismatches,breakdowns, adoption of latest technology bycompetitors, etc, come under technology risk


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` Default Risk

` Maturity Risk

` Call risk

` Natural Calamities Risk` Reinvestment Risk


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` Value at Risk (VaR) is a widely used risk measure of the risk of

loss on a specific portfolio of financial assets.` For a given portfolio, probability, and time horizon, VaR is

defined as a threshold value such that the probability that themark to market loss on the portfolio over the given time horizon

exceeds this value (assuming normal markets and no trading inthe portfolio) is the given probability level.

` For example, if a portfolio of stocks has a one-day 5% VaR of$1 million, there is a 0.05 probability that the portfolio will fall invalue by more than $1 million over a one day period if there is

no trading. Informally, a loss of $1 million or more on thisportfolio is expected on 1 day in 20.


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` Gap analysis is a technique of ALM that can be usedto assess interest rate risk. Implementations for thosetwo applications differ in minor ways, so people

distinguish between interest rate gaps.` RSG = RSA- RSL

` Gap Ratio = RSA/RSL

` Where, RSA is rate sensitive gap


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` The Macaulay duration, often simply called theduration, of a debenture/bond is a measure of theaverage time it takes an investor to get their

money (principal and interest).` Duration is expressed as a number of years.

Rising interest rates mean falling bond prices,while declining interest rates mean rising bond

prices.

`


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` Financial leverage can be defined as the degree towhich a company uses fixed-payment securities, suchas debt and preferred equity. With a high degree of

financial leverage come high interest payments. As aresult, the bottom-line earnings per share is negativelyaffected by interest payments. As interest paymentsincrease as a result of increased financial leverage, EPSis driven lower.

` Financial leverage is simply investing finances that havebeen obtained as loan to reap higher return oninvestment.

`


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` The risk an investor faces that he orshe may lose all or part of the

principal amount invested.


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` Reputational risk, often called reputation risk, isa type of risk related to the trustworthiness ofbusiness. Damage to a firm's reputation can result

in lost revenue or destruction of shareholderswealth, even if the company is not found guilty of acrime. Reputational risk can be a matter ofcorporate trust, but serves also as a tool in crisis

prevention


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types of risk-2

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