TT 300x60 - 2016.jpg

Risk refers to the relatively likelihood of an investment or asset underperforming, losing value or becoming damaged due to vulnerabilities that can be offset using risk management strategies.

Risky business

Investors recognize many different forms of financial risk, ranging from sovereign risk (a nation defaults on its government bonds) to operations risk (a bank's computer crash stops it from maintaining its obligations).[1] Trading risk, by contrast, is divided into two broad categories: systemic or market, which affects the entire market, and non-systemic or non-market, which applies to individual securities or sectors.

Both systemic and non-systemic risk can be alleviated, though not entirely eliminated, by using financial instruments like derivatives to hedge exposure to risk, especially systemic or credit risk. However, previously popular risk management derivatives like credit-default swaps and interest rate swaps were amongst the first credit markets to freeze up following the subprime mortgage collapse of 2007-08.

Hungry again?

Investors practice risk management to an extent that depends on their risk appetite, or tolerance for financial risk. Some investors are willing to gamble on high-yielding assets while others only buy safe assets like Treasuries. [2] The 2007-2008 freezing of global credit markets greatly reduced risk appetite, pushing a high number of investors into the market for U.S. Treasury bonds and greatly widening their spread with other sovereign debt. However, government-funded liquidity injected into financial markets in early October 2008 may have helped restore risk appetites as government bond spreads began to narrow, especially on the money market.[3]

References

  1. โ†‘ Risk. BusinessDictionary.com.
  2. โ†‘ Risk appetite. Forex glossary.
  3. โ†‘ Bonds slump as central banks stir appetite for risk. Reuters.
Last modified on 11 October 2013, at 12:08