Fundamental Financial Concept: Financial Risk

Definition of Financial Risk

The term financial risk covers all those multiple types of risk that is associated with financing or any type of financial transactions that includes company loans in risk of default. Financial risk also termed as the possibility of losing that a shareholder has invested in a company that is running on debt, failed to meet the financial obligations. That’s when company tend to find a way to use debt financing, which means the creditors will be repaid before the shareholders at time of insolvent.

Financial risk has other definitions, one of which defines the possibility that a corporation or government defaulting on its bonds, as a result those bondholders would lose their money. Financial risk is categorized in five board divisions which are dubbed as five risks. Modern portfolio theory which is established by Dr. Harry Markowitz in 1952 with his article based on managing market and financial risk.

Books on Financial Risk

Book 1:

Financial Risk Forecasting: The Theory and Practice of Forecasting Market Risk with Implementation in R and Matlab By Jon Danielsson (published by John Wiley & Sons, 2011)

Book 2:

Elements of Financial Risk Management By Peter F. Christoffersen (published by Academic Press, 2012)

How Financial Risk works?

• For examples, if someone lends an amount of money to a borrower, the creditor carries the risk that money will never be recovered. Likewise, when venture capital firm which makes the investment in the financial market also aware of financial risk that the investment will not profitable in the end. In the same case when someone investment in the asset, also carries financial risk that he or she will not be able to re-sell the asset.

• There are a number of financial risk ratios which reviews the prospect of investors, as an example, and the debt-to-capital ratio is used to measure the proportion of debt used, based on total capital structure of the company. When the proportion of debt is higher, this indicates risky investment.

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