Financial markets are the forums in which buyers and sellers of financial assets such as stocks and bonds, and commodities such as grains, oil and gold, meet. Because there are uncertainties of...

Risk 1
Risk
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Risk 2

Abstract
Risk is the uncertainty attached to a particular thing or event. Risk is found in every
sphere of life. In this discussion we are discussing the risk from the point of view of business.
Financial markets are the forums in which buyers and sellers of financial assets such as stocks
and bonds, and commodities such as grains, oil and gold, meet. Because there are uncertainties
of outcome, organizations must develop strategies to manage the risk associated with it. The
different types of risk, risk management techniques are also discussed.
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Risk
Risk can be called as the chance of loss or lower than expected return which can be
calculated in numerical terms. Risk is the probability that the actual return from an investment
will not be same as the desired return. Risk involves the probability of losing part or whole of the
initial investment. The risk can be measured by calculating the standard deviation of historical
returns or average returns of a particular investment. Higher the standard deviation, higher is the
risk involved.
Generally the companies put large amount of money and time in developing the risk
management techniques so as to decrease or mitigate the risk involved in their business or
investment dealings. The risk management process begins with assessment of risk which
involves identification of the risk involved in a business or investment.
There is direct relation between the risk and return. Higher the amount of risk, greater
will be the return. The main reason behind this is that investors are required to be compensated
for taking additional risk. The investment in United States Treasury bond is regarded as the
safest or risk free investment in comparison to the corporate bond and therefore gives the lower
rate of return. The main logic behind high risk in corporate bond is that there is high chance that
a company will go bankrupt than the government of United States. The risk of investment in
corporate bond is high; therefore they offer high return to investors.
A risk is defined by the Australia Standard for Risk Management (AS/NZS 4360:2004)
as “…the possibility of something happening that impacts on your objectives. It is the chance to
either make a gain or a loss. It is measured in terms of likelihood and consequence.”
Types of Risk
The risk can be of two types namely, systematic risk and unsystematic risk.
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Financial Risk: Financial Risk can be defined as the probability that the cash flows of business
are not sufficient to meet the dues of creditors and fulfill other financial responsibilities. The
financial risk is linked to the amount of debt taken by the company; it is less related to the
operations of business. Higher the debt or financial liability business owes, more is the
probability of default.
Business Risk: Business Risk can be defined as the probability that the cash flow of the business
are not sufficient to meet the operating expenses like cost of goods sold, rent and wages.
Business Risk is not dependent on the amount of liability owned by the company.
The business risk can be classified into two categories.
Systematic Risk: Systematic Risk can be called as the risk presenting the whole market.
Examples of systematic risk are interest rates, recession and wars etc. Every business operating
in the market is exposed to such type of risk. The amount of risk remains the same in every
alternative. It cannot be diversified in any way.
Unsystematic Risk: Unsystematic Risk can be called as company or industry risk that is present
in each investment. It can be reduced through diversification by holding the portfolio of
diversified industries. Example of unsystematic risk can be strike by employees of a company.
The unsystematic risk can vary from business to business. The unsystematic risk results from the
strategic, management and investment decision made by the owners.
Interest Rate Risk: The interest rate risk can be defined as the risk that the value of investment
will change due to change in the absolute level of interest rates, in the spread between two rates,
in the shape of the yield curve or in any other interest rate relationship. These changes have a
negative impact on the securities and can be decreased by diversification (investment in fixed
income securities with different variations) or hedging (interest rate swap).
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