Dr. NICHOLAS WATSON

Types of Risk Part 1 of 2

 

 

Risk and Types of Risks: adopted from: http://www.simplilearn.com

 

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. Widely, risks can be classified into three types: Business Risk, Non-Business Risk and Financial Risk.

 

• 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.

 

• 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.
   

• 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.

 

 

Financial Risk and Its Types

 

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 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 fulfill 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 fulfill 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.

 

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 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. Whenever a company needs to face financial loses out of legal proceedings, it is legal risk.

 

Business Risks adopted from: Oscar Guzman, Demand Media

 

Business risk refers to the chance a business's cash flows are not enough to cover its operating expenses like cost of goods sold, rent and wages. Unlike financial risk, business risk is independent of the amount of debt a business owes. There are two types of business risk: systematic risk and unsystematic risk.

 

Systematic Risk

Systematic risk refers to the chance an entire market or economy will experience a downturn or even fail. Economic crashes, recessions, wars, interest rates and natural disasters are common sources of systematic risk. Any business operating in the market is exposed to this risk, and the amount of systematic risk does not vary between businesses in the same market. Therefore there is little small business owners can do to decrease their exposure to systematic risk.

 

Unsystematic Risk

Unsystematic risk describes the chance a specific company or line of business will experience a downturn or even fail. Unlike systematic risk, unsystematic risk can vary greatly from business to business. Sources of unsystematic risk include the strategic, management and investment decisions a small business owner faces every day. Investors decrease their exposure to unsystematic risk by diversifying their portfolio and holding ownership in a variety of companies operating in a variety of industries.

 

Non Business Risks

This article was obtained from: www.accaglobal.com

 

Companies often focus on business risks that could derail their earnings. However, as recent events show, other risks often fly under the radar of executives and directors

 

This article was first published in the January 2015 Singpaore edition of Accounting and Business magazine.

Singapore residents have got used to the city-state being shrouded by a blanket of haze at certain times of the year, and it happened again last October.

 

The pollution, caused by forest and plantation fires in parts of Indonesia, hit hard on certain days, although the situation was far better than in 2013, when the air quality hit hazardous levels for the first time in Singapore’s history.

 

Further afield, Hong Kong has seen widespread demonstrations, with parts of the territory blockaded by protestors.

Such incidents may seem a world away from income statements and balance sheets, yet firms would do well to pay attention, and develop strategies and contingency plans to deal with these ‘non-business risks’.

 

Simply put, business risks are inherent in the operations and running of a company. They include scenarios like a product failure, the cessation of operations by a key supplier, or simply a prolonged market downturn. 

 

Executives spend plenty of time developing plans to deal with such risks, because there are clear links between them and the profitability of the business. There are often obvious solutions. For instance, by purchasing raw materials from a variety of suppliers, companies will drastically lower the negative impact of any one supplier collapsing.

 

Non-business risks, on the other hand, arise due to factors other than carrying out business transactions and running a company. The category is broadly defined and can include anything from environmental risks – as in the case of haze or a typhoon – to political and security risks. As the range of such risks is so wide, companies often fail to spend enough time planning for these possible scenarios.

 

Managers tend to associate non-business risks with catastrophic ‘black swan events’ such as the 9/11 terrorist attacks or the 2011 earthquake and tsunami in Japan. These are rare and difficult to predict, and companies may grow complacent that they will never be affected.

 

But while large-scale terrorist attacks and natural disasters are thankfully still uncommon, each incident has a compelling effect on businesses and investments. The 9/11 attacks worsened the recession in the US, while Japan’s fragile economy was tipped into recession by the 2011 tsunami.

 

Non-business risks are not confined to terrorism, war and catastrophes; other events have the potential to hit bottom lines, too. For example, the Hong Kong protests have impacted the retail sector as consumers found access restricted to popular shopping districts, while tourism may have slowed as visitors delay their travel plans. Meanwhile, in the financial sector, bankers and fund managers have commented on the impact on their daily commutes.

 

Businesses also need to be aware of environmental risks. The 2013 haze impacted restaurants, tourist attractions and retail outlets in South-East Asia. A similar crisis in 1997 cost Singapore’s economy some US$300m and South-East Asia’s economies about US$9bn – owing to the disruption of travel and business activities, as well as higher healthcare costs.

How, then, can companies ensure that their operations and strategies are not undermined by such events?

 

Business continuity management is one commonly used method to mitigate non-business risks. This refers to a comprehensive process of identifying potential threats and building a framework for an effective response. The aim is to safeguard the brand and the interests of stakeholders, by ensuring that business activities and customer support can continue during any crisis.

 

A key aspect is the training and drills before any crisis event hits. This allows staff members to know what to do in an actual situation and ensures that the company’s business continuity plans keep up to date. Many Singapore companies already have such plans in place, thanks largely to the haze crises. During the 2013 incident, businesses distributed masks to staff to filter out airborne particulates, while some employees were allowed to work from home.

 

It does not take long for a company to weigh non-business risks and boost the resilience of its operations. Such preparations could prove invaluable.