Financial risk is the entirety of risks related to the financial loss of an investor. Simply put, it is the risk of loss in trading or investment.
Financial risk can arise from external factors such as financial market fluctuations, investor decisions affecting debt obligations and cash flow control.
The essence of financial risk is the difference between actual value and expected value, reflecting the sensitivity of profit.
Some common types of financial risks include:
Market risk: This is the risk from market price fluctuations, changes in the economy, and financial reports from companies that directly affect the value of investments. Interest rates impact the financial market in two ways, directly and indirectly. Interest rates directly affect bonds and fixed-income securities, while indirectly affecting stocks.
Credit risk: It occurs to lenders when their borrowers default. On a macro scale, if a country faces significant credit risk, economic crises are likely to occur.
Liquidity risk: It includes risks regarding asset and capital liquidity, indicating the difficulty in converting assets and capital into cash when sudden demand arises. For instance, poor cash flow management leading to a lack of cash to pay off debts or fund urgent activities represents liquidity risk.
Legal risk: It pertains to potential losses arising when investors fail to comply with legal regulations or rules within the legal framework (such as insider trading or corruption).
Interest rate risk: This is the risk from unfavorable interest rate fluctuations in the market affecting valuable securities, financial instruments with interest rates, and derivative products. Typically, this risk stems from bank borrowing.
Financial decision-making risk: Often, investor decisions to buy or sell may be wrong, resulting in capital and profit losses.
Additionally, there are many other risks, such as operational risks, loss risks, investment and investment management risks, exchange rate risks, financial management system risks, audit risks, financial planning risks, etc.
Financial risk can negatively impact:
Profit: In the long run, financial risk can lead to profit erosion if not prevented. Consequently, future cash flows that investors may receive may also decrease.
Initial capital: Investors not only risk losing profits but also risk losing their entire capital (companies going bankrupt, investors defaulting).
Investor status: If facing legal trouble or a decrease in creditworthiness, investors may not have enough trust to continue borrowing.
Financial risk significantly affects the investment process.
The process of assessing and dealing with financial risks is called financial risk management.
Risk management is extremely important, providing direction and successful strategies for investment activities, helping investors avoid potential risks proactively and be ready to face unexpected difficulties while seeking sustainability and stability in profits.
The role of financial risk management
The essence of risk management is to eliminate passivity, identify possible outcomes in investment activities to find ways to improve efficiency. Planning is the best way, with adjustments made based on appropriate tools rather than randomly.
Financial managers must identify all impacts and risks, thereby identifying the most critical keys to change for the best outcomes.
Investors can apply several solutions to manage financial risks:
Minimize financial risks: Use risk analysis tools for investments, aggregate business situations, assets, income, analyze data, regularly assess stocks, and calculate debt-to-equity ratios in financial structures.
Choose futures contracts, put options, swap contracts: Always be informed of market trends quickly and have a deep understanding of financial law systems, always consciously comply with the law.
Control cash flow strictly, set up reserve funds or purchase insurance, avoid excessive borrowing.
Use financial management software to monitor cash flow effectively.