Finance And Business Risks Research Assignment Paper (Essay Sample)

Finance and business risks
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Financial and business risks
Financial risk refers to a company's ability to manage its debt and financial leverage, while business risk refers to the company's ability to generate sufficient revenue to cover its operational expenses.
Financial risk
Financial risk is the possibility that shareholders will lose money when they invest in a company that has debt, if the company's cash flow proves inadequate to meet its financial obligations.
Financial risk is the general term for many different types of risks related to the finance industry. These include risks involving financial transactions such us company loans, and its exposure to loan default. The term is typically used to reflect an investor's uncertainty of collecting returns and the potential for monetary loss.
Types of Financial Risks
Credit risk is also referred to as default risk. This type of risk is associated with people who borrowed money and who are unable to pay for the money they borrowed. As such, these people go into default. Investors affected by credit risk suffer from decreased income and lost principal and interest, or they deal with a rise in costs for collection.
Liquidity risk involves securities and assets that cannot be purchased or sold fast enough to cut losses in a volatile market. Asset-backed risk is the risk that asset-backed securities may become volatile if the underlying securities also change in value. The risks under asset-backed risk include prepayment risk and interest rate risk.
Changes in prices because of market differences, political changes, natural calamities, diplomatic changes or economic conflicts may cause volatile foreign investment conditions that may expose businesses and individuals to foreign investment risk. Equity risk covers the risk involved in the volatile price changes of shares of stock.
Investors holding foreign currencies are exposed to currency risk because different factors, such as interest rate changes and monetary policy changes, can alter the value of the asset that investors are holding.
Market risk is the possibility for an investor to experience losses due to factors that affect the overall performance of the financial markets in which he is involved. Market risk, also called "systematic risk," cannot be eliminated through diversification, though it can be hedged against. Sources of market risk include recessions, political turmoil, changes in interest rates, natural disasters and terrorist attacks.
Country risk is a collection of risks associated with investing in a foreign country. These risks include political risk, exchange rate risk, economic risk, sovereign risk and transfer risk, which is the risk of capital being locked up or frozen by government action. Country risk varies from one country to the next. Some countries have high enough risk to discourage much foreign investment.
A risk management method used in the business or investment field. Accepting risk occurs when the cost of managing a certain type of risk is accepted, because the risk involved is not adequate enough to warrant the added cost it will take to avoid that risk.
Default risk is the chance that companies or individuals will be unable to the required payments on their debt obligations. Lenders and investors are exposed to default risk in virtually all forms of credit extensions. To mitigate the impact of default risk, lenders often charge rates of return that correspond the debtor's level of default risk. A higher level of risk leads to a higher required return.
The possibility that a company will be unable to meet its debt obligations. Bankruptcy risk describes the likelihood that a firm will become insolvent because of its inability to service its debt. A firm can fail financially because of cash flow problems resulting from inadequate sales and high operating expenses. To address the cash flow problems, the firm might increase its short-term borrowings. If the situation does not improve, the firm is at risk of insolvency or bankruptcy. Many investors consider a firm's bankruptcy risk prior to making equity or bond investment decisions. Agencies such as Moody's and Standard & Poor's attempt to assess risk by giving bond ratings. Also called "insolvency risk.".
Solvency is measured with a liquidity ration called the "current ratio," a comparison between current assets (including cash on hand and any assets that could be converted into cash within 12 months such as inventory, receivables and supplies) and current liabilities (debts that are due within the next 12 months, such as interest and principal payments on debt serviced, payroll and payroll taxes). There are many ways to interpret the current ratio. For example, the textbook "Contemporary Financial Management" considers a 2:1 current ratio as solvent, showing that the firm's current assets are twice its current liabilities. In other words, the firm's assets would cover its current liabilities about two times.
Debt financing occurs when a firm raises money for working capital or capital expenditures by selling bonds, bills or notes to individuals and/or institutional investors. In return for lending the money, the individuals or institutions become creditors and receive a promise the principal and interest on the debt will be repaid. The other way to raise capital in the debt markets is to issue shares of stock in a public offering; this is called equity financing.
When a company needs money, it can take three routes to obtain financing: cash, debt or some hybrid of the two. Equity represents an ownership stake in the company. It gives the shareholder a claim on future earnings, but it does not need to be paid back. If the company goes bankrupt, equity holders are the last in line to receive money. The first investors in line are the lenders. These are the investors that provide the company with debt financing. The amount of the investment loan, referred to as the principal, must be paid back. Companies can obtain debt financing through banks and bondholders.
A risk profile is an evaluation of an individual or organization's willingness to take risks, as well as the threats to which an organization is exposed. A risk profile is important for determining a proper investment asset allocation for a portfolio. Organizations use a risk profile as a way to mitigate potential risks and threats.
In general, a greater risk associated with any investment should require a greater return. Either risk profile – whether used to describe the willingness to accept risk or an evaluation of the risks to which an entity is exposed – can be expressed in a graph. Risk is often measured in terms of risk probability (the likelihood that a risk will occur) and risk impact (a measure of the consequences if the risk occurs). Investors can evaluate the risk to which a portfolio is exposed and make decisions based on this risk and their willingness to accept
Risk Asset
A risk asset is any asset that carries a degree of risk. Risk asset generally refers to assets that have a significant degree of price volatility, such as equities, commodities, high-yield bonds, real estate and currencies. Specifically in the banking context, risk asset refers to an asset owned by a bank or financial institution whose value may fluctuate due to changes in interest rates, credit quality, repayment risk and so on. The term may also refer to equity capital in a financially stretched or near-bankrupt company, as its shareholders’ claims would rank below those of the firm’s bondholders’ and other lenders.
Business risk
Business risk is the possibility a company will have lower than anticipated profits or experience a loss rather than taking a profit. Business risk is influenced by numerous factors, including sales volume, per-unit price, input costs, competition, the overall economic climate and government regulations. A company with a higher business risk should choose a capital structure that has a lower debt ratio to ensure it can meet its financial obligations at all times.
Types of Business Risk
Business risk usually occurs in one of four ways: strategic risk, compliance risk, operational risk and reputational risk.
Strategic risk arises when the implementation of a business does not go according to the business model or plan. A company's strategy becomes less effective over time, and it struggles to reach its defined goals. If, for example, Wal-Mart strategically positions itself as a low-cost provider and Target decides to undercut Wal-Mart's prices, this becomes strategic risk.
The second form of business risk is compliance risk. This type of risk arises in industries and sectors highly regulated with laws. The wine industry, for example, must adhere to the three-tier system of distribution, where it is a requirement for a wholesaler to sell wine to a retailer, who in turn sells it to the end consumer. Wineries cannot sell directly to retail stores. However, there are 18 states that do not have this type of distribution system, and compliance risk arises when a brand fails to unde...