RiskIn simple terms, risk is the possibility of something bad happening. Risk involves uncertainty about the effects/implications of an activity with respect to something that humans value (such as health, well-being, wealth, property or the environment), often focusing on negative, undesirable consequences. Many different definitions have been proposed. The international standard definition of risk for common understanding in different applications is "effect of uncertainty on objectives".
Financial riskFinancial risk is any of various types of risk associated with financing, including financial transactions that include company loans in risk of default. Often it is understood to include only downside risk, meaning the potential for financial loss and uncertainty about its extent. A science has evolved around managing market and financial risk under the general title of modern portfolio theory initiated by Harry Markowitz in 1952 with his article, "Portfolio Selection".
Risk aversionIn economics and finance, risk aversion is the tendency of people to prefer outcomes with low uncertainty to those outcomes with high uncertainty, even if the average outcome of the latter is equal to or higher in monetary value than the more certain outcome. Risk aversion explains the inclination to agree to a situation with a more predictable, but possibly lower payoff, rather than another situation with a highly unpredictable, but possibly higher payoff.
Value at riskValue at risk (VaR) is a measure of the risk of loss of investment/Capital. It estimates how much a set of investments might lose (with a given probability), given normal market conditions, in a set time period such as a day. VaR is typically used by firms and regulators in the financial industry to gauge the amount of assets needed to cover possible losses. For a given portfolio, time horizon, and probability p, the p VaR can be defined informally as the maximum possible loss during that time after excluding all worse outcomes whose combined probability is at most p.
Credit riskCredit risk is the possibility of losing a lender holds due to a risk of default on a debt that may arise from a borrower failing to make required payments. In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased collection costs. The loss may be complete or partial. In an efficient market, higher levels of credit risk will be associated with higher borrowing costs.
DebtDebt is an obligation that requires one party, the debtor, to pay money borrowed or otherwise withheld from another party, the creditor. Debt may be owed by sovereign state or country, local government, company, or an individual. Commercial debt is generally subject to contractual terms regarding the amount and timing of repayments of principal and interest. Loans, bonds, notes, and mortgages are all types of debt. In financial accounting, debt is a type of financial transaction, as distinct from equity.
European debt crisisThe European debt crisis, often also referred to as the eurozone crisis or the European sovereign debt crisis, was a multi-year debt crisis that took place in the European Union (EU) from 2009 until the mid to late 2010s. Several eurozone member states (Greece, Portugal, Ireland, Spain, and Cyprus) were unable to repay or refinance their government debt or to bail out over-indebted banks under their national supervision without the assistance of third parties like other eurozone countries, the European Central Bank (ECB), or the International Monetary Fund (IMF).
Risk premiumA risk premium is a measure of excess return that is required by an individual to compensate being subjected to an increased level of risk. It is used widely in finance and economics, the general definition being the expected risky return less the risk-free return, as demonstrated by the formula below. Where is the risky expected rate of return and is the risk-free return. The inputs for each of these variables and the ultimate interpretation of the risk premium value differs depending on the application as explained in the following sections.
Credit default swapA credit default swap (CDS) is a financial swap agreement that the seller of the CDS will compensate the buyer in the event of a debt default (by the debtor) or other credit event. That is, the seller of the CDS insures the buyer against some reference asset defaulting. The buyer of the CDS makes a series of payments (the CDS "fee" or "spread") to the seller and, in exchange, may expect to receive a payoff if the asset defaults.
Probability of defaultProbability of default (PD) is a financial term describing the likelihood of a default over a particular time horizon. It provides an estimate of the likelihood that a borrower will be unable to meet its debt obligations. PD is used in a variety of credit analyses and risk management frameworks. Under Basel II, it is a key parameter used in the calculation of economic capital or regulatory capital for a banking institution. PD is closely linked to the expected loss, which is defined as the product of the PD, the loss given default (LGD) and the exposure at default (EAD).
Liquidity riskLiquidity risk is a financial risk that for a certain period of time a given financial asset, security or commodity cannot be traded quickly enough in the market without impacting the market price. Market liquidity – An asset cannot be sold due to lack of liquidity in the market – essentially a sub-set of market risk.
Consumer debtIn economics, consumer debt is the amount owed by consumers (as opposed to amounts owed by businesses or governments). It includes debts incurred on purchase of goods that are consumable and/or do not appreciate. In macroeconomic terms, it is debt which is used to fund consumption rather than investment. The most common forms of consumer debt are credit card debt, payday loans, student loans and other consumer finance, which are often at higher interest rates than long-term secured loans, such as mortgages.
Risk assessmentRisk assessment determines possible mishaps, their likelihood and consequences, and the tolerances for such events. The results of this process may be expressed in a quantitative or qualitative fashion. Risk assessment is an inherent part of a broader risk management strategy to help reduce any potential risk-related consequences. More precisely, risk assessment identifies and analyses potential (future) events that may negatively impact individuals, assets, and/or the environment (i.e. hazard analysis).
Money marketThe money market is a component of the economy that provides short-term funds. The money market deals in short-term loans, generally for a period of a year or less. As short-term securities became a commodity, the money market became a component of the financial market for assets involved in short-term borrowing, lending, buying and selling with original maturities of one year or less. Trading in money markets is done over the counter and is wholesale.
Moral hazardIn economics, a moral hazard is a situation where an economic actor has an incentive to increase its exposure to risk because it does not bear the full costs of that risk. For example, when a corporation is insured, it may take on higher risk knowing that its insurance will pay the associated costs. A moral hazard may occur where the actions of the risk-taking party change to the detriment of the cost-bearing party after a financial transaction has taken place.
Unsecured debtIn finance, unsecured debt refers to any type of debt or general obligation that is not protected by a guarantor, or collateralized by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the terms for repayment. Unsecured debts are sometimes called signature debt or personal loans. These differ from secured debt such as a mortgage, which is backed by a piece of real estate.
Derivative (finance)In finance, a derivative is a contract that derives its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the underlying. Derivatives can be used for a number of purposes, including insuring against price movements (hedging), increasing exposure to price movements for speculation, or getting access to otherwise hard-to-trade assets or markets.
External debtA country's gross external debt (or foreign debt) is the liabilities that are owed to nonresidents by residents. The debtors can be governments, corporations or citizens. External debt may be denominated in domestic or foreign currency. It includes amounts owed to private commercial banks, foreign governments, or international financial institutions such as the International Monetary Fund (IMF) and the World Bank. External debt measures an economy's obligations to make future payments and, therefore, is an indicator of a country's vulnerability to solvency and liquidity problems.
High-yield debtIn finance, a high-yield bond (non-investment-grade bond, speculative-grade bond, or junk bond) is a bond that is rated below investment grade by credit rating agencies. These bonds have a higher risk of default or other adverse credit events, but offer higher yields than investment-grade bonds in order to compensate for the increased risk. As indicated by their lower credit ratings, high-yield debt entails more risk to the investor compared to investment grade bonds.
Asset and liability managementAsset and liability management (often abbreviated ALM) is the practice of managing financial risks that arise due to mismatches between the assets and liabilities as part of an investment strategy in financial accounting. ALM sits between risk management and strategic planning. It is focused on a long-term perspective rather than mitigating immediate risks and is a process of maximising assets to meet complex liabilities that may increase profitability.
