Corporates analyze market risks (in particular FX risks) in terms of three key exposures: transaction exposures, economic exposures, and translation exposures. Let us discuss each of these exposures. Transaction Exposures Transaction exposures arise because of adverse changes in prices. For example, a US based company buying goods from a Japanese company will incur transaction risk […]
Identifying Risks
Typology of Risks
In their normal course of business, corporations face a variety of risks. The primary risks involved are business risk, market risk, credit risk, and operational risk. The corporations are expected to deal with different risk in different ways. They are expected to take business risk, manage market and credit risk, while mitigate operational risk. Here […]
Types of Market Risk
There are four major types of market risk: Interest Rate Risk Equity Price Risk Foreign Exchange Risk Commodity Price Risk Interest Rate Risk Interest rate risk is the risk that the value of a security will fall as a result of increase in interest rates. However, in complex portfolios, many different types of exposures can […]
Overview of Credit Risk
Over the past few years, financial institutions have faced severe difficulties due to various reasons. However, the major cause of the banking problem is directly related to lax credit standards for borrowers and counterparties, poor portfolio risk management, or a lack of attention to changes in economic or other circumstances leading to a deterioration in […]
Defaults and Ratings Changes
The transition matrix below shows the probability of default and credit rating migrations for each credit rating. Transition matrices can be calculated by observing the historical pattern of rating change and default. They have been published by S&P and Moody’s rating agencies. To read the table, find today’s rating on the left and follow along […]
Overview of Operational Risk
Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, but excludes strategic and reputational risk. Legal risk includes, but is not limited to, exposure to fines, penalties, or punitive damages resulting from supervisory actions, as well […]
Event Risk and Its Management
Event risk involves a severe and sudden shock that can arise from any general type of risk, including human error, operational risk, natural disasters, currency devaluations, and stock market crashes. Difficult to predict Event risks are difficult to predict, but once an event strikes, we know there will be aftershocks. Hence, it is important to […]
Systemic Risk
Systemic risks, as opposed to unique or firm-specific risks, are the most troublesome because they have the potential to affect anyone. Systemic risks may arise from common factors (for example, market and economic factors, weather, natural disasters, computer viruses, war) and can influence the whole market’s well-being. Unlike firm-specific risk, systemic risk cannot be diversified […]