Types of Financial Risks with an Example each!
Updated: Jan 4
There are several types of financial risks that investors and businesses may face:
Credit risk: Credit risk refers to the risk that a borrower will default on a loan or bond, resulting in a loss for the lender. For example, if a company takes out a loan and is unable to make the required payments, the lender may suffer a loss.
Liquidity risk: Liquidity risk refers to the risk that an investor or business will not be able to meet its financial obligations due to a lack of cash or other liquid assets. For example, if a company has a lot of assets but they are not easily converted to cash, it may struggle to pay its bills if it experiences a downturn in business.
Interest rate risk: Interest rate risk refers to the risk that changes in interest rates will adversely impact the value of an investment. For example, if an investor has a bond with a fixed interest rate and market interest rates rise, the value of the bond may decline because it is less attractive to new investors.
Market risk: Market risk refers to the risk that the value of an investment will decline due to changes in market conditions. For example, if a company's stock is heavily reliant on the performance of a particular industry and that industry experiences a downturn, the value of the company's stock may also decline.
Inflation risk: Inflation risk refers to the risk that the purchasing power of an investment will decline over time due to inflation. For example, if an investor puts money into a savings account that only earns a low interest rate, the purchasing power of that money may decline over time as prices rise due to inflation.
Exchange rate risk: Exchange rate risk refers to the risk that changes in exchange rates will negatively impact the value of an investment. For example, if an investor has assets denominated in a foreign currency and the value of that currency declines relative to the investor's domestic currency, the value of the investment may also decline.
Political risk: Political risk refers to the risk that government action or instability will negatively impact the value of an investment. For example, if an investor has assets in a country with a volatile political environment, the value of those assets may be at risk due to changes in government policies or instability.
Operational risk: Operational risk refers to the risk that business operations will be disrupted or that financial losses will be incurred as a result of failure or mistakes in internal processes, systems, or human error. For example, if a company's computer systems fail, it may be unable to process orders or transactions, leading to financial losses.
Legal risk: Legal risk refers to the risk that a business or investment will be adversely impacted by legal action or changes in regulations. For example, if a company is found to be in violation of a law or regulation, it may face fines or legal action that could negatively impact its financial performance.