DEFINITION of 'Business Risk'The possibility that a company will have lower than anticipated profits, or that it will experience a loss rather than a profit. Business risk is influenced by numerous factors, including sales volume, per-unit price, input costs, competition, overall economic climate and government regulations. A company with a higher business risk should choose a capital structure that has a lower debt ratio to ensure that it can meet its financial obligations at all times.The term business risk refers to the possibility of inadequate profits or even losses due to uncertainties e.g., changes in tastes, preferences of consumers, strikes, increased competition, change in government policy, obsolence etc .Every business organization contains various risk elements while doing the business. Business risks implies uncertainty in profits or danger of loss and the events that could pose a risk due to some unforeseen events in future, which causes business to fail.[1][2][3]For example, an owner of a business may face different risks like in production,risks due to irregular supply of raw materials, machinery breakdown, labor unrest, etc. In marketing, risks may arise due to different market price fluctuations, changing trends and fashions, error in sales forecasting, etc. In addition, there may be loss of assets of the firm due to fire, flood, earthquakes, riots or war and political unrest which may cause unwanted interruptions in the business operations. Thus business risks may take place in different forms depending upon the nature and size of the business.Business risks can be classified by the influence by two major risks: internal risks (risks arising from the events taking place within the organization) and external risks (risks arising from the events taking place outside the organization).[4]Internal risks arise from factors (endogenous variables, which can be controlled) such as human factors (talent management, strikes), technological factors (emerging technologies), physical factors (failure of machines, fire or theft), operational factors (access to credit, cost cutting, advertisement). External risks arise from factors (exogenous variables, which cannot be controlled) such as economic factors (market risks, pricing pressure), natural factors (floods, earthquakes), political factors (compliance and regulations of government).[

INVESTOPEDIA EXPLAINS 'Business Risk'Investors in a company are exposed not only to business risk, but also to financial risk, liquidity risk, systematic risk, exchange-rate risk and country-specific risk. To calculate business risk, analysts use four simple ratios: contribution margin, operation leverage effect, financial leverage effect and total leverage effect. For more complex calculations, analysts can incorporate statistical methods.ClassificationThe Business risk is classified into different 5 main types[7]1. Strategic Risk: They are the risks associated with the operations of that particular industry.These kind of risks arise from 1. Business Environment: Buyers and sellers interacting to buy and sell goods and services, changes in supply and demand, competitive structures and introduction of new technologies.2. Transaction: Assets relocation of mergers and acquisitions, spin-offs, alliances and joint ventures.3. Investor Relations: Strategy for communicating with individuals who have invested in the business.2. Financial Risk: These are the risks associated with the financial structure and transactions of the particular industry.3. Operational Risk: These are the risks associated with the operational and administrative procedures of the particular industry which are very common in today's generation.4. Compliance Risk(Legal Risk): These are risks associated with the need to comply with the rules and regulations of the government.5. Other risks: There would be different risks like natural disaster(floods) and others depend upon the nature and scale of the industrEntrepreneurs understand owning and operating a business involves accepting a level of risk: risk that your business may not succeed, risk that you may not recover your investment. The amount of risk varies between businesses and is an important factor in determining a business's value. The two main types of risk small business owners are exposed to are financial risk and business riskDifferences Between Business Risk & Financial RiskFinancial RiskFinancial risk refers to the chance a business's cash flows are not enough to pay creditors and fulfill other financial responsibilities. The level of financial risk, therefore, relates less to the business's operations themselves and more to the amount of debt a business incurs to finance those operations. The more debt a business owes, the more likely it is to default on its financial obligations. Taking on higher levels of debt or financial liability therefore increases a business's level of financial risk.Business RiskBusiness risk refers to the chance a business's cash flows are not enough to cover its operating expenses like cost of goods sold, rent and wages. Unlike financial risk, business risk is independent of the amount of debt a business owes.

Factors Affecting Business RiskThe business risk of a firm is measured by the variability in operating income of the firm. Larger variability in operating income denotes larger business risk. The firm's business risk changes over time and it varies from firm to firm. Some factors affecting business risk of a firm are as follows:

1. Variability In DemandThe operating income of the firm fluctuates widely if variability in demand for firm's product is larger. Thus, a firm with larger variability in demand is more exposed to business risk.

2. Variability In Selling PriceA firm's product does not sell at constant price. The selling price of the firm's product may be volatile because of alternative demand and supply conditions, nature of competitions and so on. Thus, larger the variability in selling price wider will be the fluctuations in operating income leading to higher business risk.

3. Uncertainty Of Input CostsCost of input keeps on changing over time, affecting the total cost of output. The total operating cost of the firm widely fluctuates if the uncertainty associated to input cost is larger. This exposes the firm to high business risk.

4. Ability To Price AdjustmentWhen there is an increase in input costs, the selling price must also increase to maintain the stability in firm's operating income. However, the speed with which selling price is adjusted in response to the change in input costs, depends on price adjustment capacity of the firm.Thus, higher the firm's ability to price adjustment, lower will be the business risk.

5. Speed Of Technological ChangesThe firm should adapt to changing technology over the years. If the speed of technological changes is greater and the firm is not able to adapt to changing technology, demand for firm's product will be adversely affected. The level of business risk associated to such firm is larger.

6. Extent Of Fixed Operating CostsIf larger portion of the firm's costs are fixed, the firm has to make larger sales to meet the fixed costs. At lower sales level such firm is not able to meet the fixed cost. There larger fixed cost exposes the firm to larger degree of business risk.7. Market Fluctuations Semiconductor market fluctuations, which are caused by such factors as economic cycles in each region and shifts in demand of end customers, affect the Group. Although the Group carefully monitors changes in market conditions, it is difficult to completely avoid the impact of market fluctuations due to economic cycles in countries around the world and changes in the demand for end products. Market downturns, therefore, could lead to decline in product demand and increase in production and inventory amounts, as well as lower sales prices. Consequently, market downturns could reduce the Group's sales, as well as lower fab utilization rates, which may in turn result in worsened cost ratios, ultimately leading to deterioration in profits.8. Fluctuations in foreign exchange and interest rates The Group engages in business activities in all parts of the world and in a wide range of currencies. As a result our consolidated business results and financial condition are affected by fluctuations in foreign exchange rates. To reduce these effects of exchange rate fluctuations, the Group implements a variety of measures, including entering into exchange rate futures contracts. However, it is still possible for our sales volume in foreign currencies, our materials costs in foreign currencies, our production costs at overseas manufacturing sites, and other items to be influenced if exchange rates change significantly. Also, the Renesas Group assets, liabilities, income, and costs can change greatly by showing our foreign currency denominated assets and debts converted to amounts in Japanese yen, and these can also change when financial statements in foreign currencies at our overseas subsidiaries are converted to and presented in Japanese yen. Furthermore, since costs and the values of assets and debts associated with Renesas Group business operation are influenced by fluctuations in interest rates, it is also possible for Renesas Group businesses, performance, and financial condition to be adversely influenced by these fluctuations.9. Natural Disasters Natural disasters such as earthquakes, typhoons, and floods, as well as accidents, acts of terror, infection and other factors beyond the control of the Group could adversely affect the Group's business operation. Especially, as the Group owns key facilities and equipment in areas where earthquakes occur at a frequency higher than the global average, the effects of earthquakes and other events could damage the Group's facilities and equipment and force a halt to manufacturing and other operations, and such events could consequently cause severe damage to the Group's business. The Group sets and manages several preventive plans and Business Continuity Plan which defines countermeasures such as contingency plans and at the same time the Group is subscribed to various insurances; however, these plans and insurances are not guaranteed to cover all the losses and damages incurred.

10. Competition The semiconductor industry is extremely competitive, and the Group is exposed to fierce competition from rival companies around the world in areas such as product performance, structure, pricing and quality. To maintain and improve competitiveness, the Group takes various measures including development of leading edge technologies, standardizing design, and cost reduction, but in the event that the Group cannot maintain its competitiveness, the Group's market share may decline, which may negatively impact the Group's financial results. Price competition for the purpose of maintaining market share may also lead to sharp declines in the market price of the Group's products. When this cannot be offset by cost reductions, the Group's gross profit margin ratio may decline11. Implementation of Management Strategies and Structural Measures The Group is implementing a variety of business strategies (such as strengthening our microcontroller, Analog & Power device businesses and accelerating our selection and concentration of SoC solutions) and structural measures (such as production structural reforms and workforce reforms) to strengthen the foundations of our profitability. However, due to changes in economic conditions and the business environment, factors whose future is uncertain, and unforeseeable factors, it is possible that some of those reforms may become difficult to carry out and others may not achieve the originally planned results. Furthermore, additional structural reform costs may arise. Thus these issues may adversely influence Renesas Group performance and financial condition.12. Business Activities Worldwide The Group conducts business worldwide, which can be adversely affected by factors such as barriers to long-term relationships with potential customers and local enterprises; restrictions on investment and imports/exports; tariffs; fair trade regulations; political, social, and economic risks; outbreaks of illness or disease; exchange rate fluctuations; drops in individual consumption or in equipment investment; fluctuations in the prices of goods and land; and rising wage levels. As a result, the Group may fail to achieve its initial targets regarding business in overseas markets, which could have a negative impact on the business growth and performance of the Group.13. Strategic Alliance and Corporate Acquisition For business expansion and strengthening of competitiveness, the Group may engage in strategic alliances, including joint investments, and corporate acquisitions involving third parties in the areas of R&D on key technologies and products, manufacturing, etc. The Group studies from many aspects the potential of these alliances and acquisitions in terms of return on investment and profitability, but time and money are necessary to achieve integration in areas such as business execution, technology, products, and personnel, and it is possible that these collaborative relationships cannot be sustained due to issues such as differences from the Group's partners on management strategy in areas such as capital procurement, technology management, and product development, or financial or other business problems the Group's partners may encounter. In addition, it is not guaranteed that strategic alliances and corporate acquisitions would actually yield the results initially anticipated.14. Financing While the Group has been procuring business funds by methods such as borrowing from financial institutions and other sources, in the future it may become necessary to procure additional financing to implement business and investment plans, expand manufacturing capabilities, acquire technologies and services, and repay debts. It is possible that the Renesas Group may face limitations on its ability to raise funds due to a variety of reasons, including the fact that the Group may not be able to acquire required financing in a timely manner or may face increasing financing costs due to the worsening business environment in the semiconductor industry, worsening conditions in the financial and stock markets, and changes in the lending policies of lenders. In addition, some of the borrowing contracts executed between the Group and some financial institutions stipulate articles of financial covenants. If the Group breaches these articles due to worsened financial base of the Group etc., the Group may lose the benefit of term on the contract, and it may adversely influence the Group's business performance and financial conditions.15. Notes on Additional Financing After implementing of the allocation of new shares to a third party based on a decision at the Meeting of the Board of Directors held on December 10, 2012, we received an offer from the Innovation Network Corporation of Japan that they are willing to provide additional investments or loans with an upper limit of 50 billion yen. Currently, no specific details regarding the timing of or conditions associated with these additional investments or loans have been determined, and there is no guarantee that these additional investments or loans will actually be implemented. If investments occur based on this offer, further dilution of existing stock will occur and this may adversely impact existing shareholders. Also, if loans are made under this offer, Renesas' outstanding interest-bearing debt will increase and this may impose restrictions on some of our business activities. Furthermore, if fluctuations in interest rates occur in the future, Renesas Group businesses, performance, and financial condition may be adversely affected.16. Notes on Relationship with Major Shareholder that Has a Majority of Voting Rights Renesas issued common stocks through the third-party allotment to the Innovation Network Corporation of Japan and other companies on September 30, 2013. As a result of its subscription, the Innovation Network Corporation of Japan became the major shareholder that has a majority of the voting rights in Renesas. The exercise of voting rights associated with the stocks by the Innovation Network Corporation of Japan at the ordinary general meeting of shareholders may have significant influences on the Group's business operations. Also, the Innovation Network Corporation of Japan owns stocks for the purpose of investment, and therefore, when the Innovation Network Corporation of Japan sells those stocks in the market in the future, it may have significant influences on the stock price of Renesas, depending on the market environment at the time of such sale.17. Rapid Technological Evolutions and Other Issues The semiconductor market in which the Group does business is characterized by rapid technological changes and rapid evolution of technological standards. Therefore, if the Group is not able to carry out appropriate research and development, Renesas Group businesses, performance, and financial condition may all be adversely affected by product obsolescence and the appearance of competing products.18. Product Production a. Production Process Risk Semiconductor products require extremely complex production processes. In an effort to increase yields (ratio of non-defective products from the materials used), the Group takes steps to properly control production processes and seeks ongoing improvements. However, the emergence of problems in these production processes could lead to worsening yields. This problem, in turn, could trigger shipment delays, reductions in shipment volume, or, at worst, the halting of shipments. b. Procurement of Raw Materials, Components, and Production Facilities The timely procurement of necessary raw materials, components and production facilities is critical to semiconductor production. To avoid supply problems related to these essential raw materials, components and production facilities, the Group works diligently to develop close relationships with multiple suppliers. Some necessary materials, however, are available only from specific suppliers. Consequently, insufficient supply capacity amid tight demand for these materials as well as events including natural disasters, accidents, worsening of business conditions, and withdrawal from the business occurred in suppliers could preclude their timely procurement, or may result in sharply higher prices for these essential materials upon procurement. c. Risks Associated with Outsourced Production The Group outsources the manufacture of certain semiconductor products to external foundries (contract manufacturers) and other entities. In doing so, the Group selects its trusted outsourcers, rigorously screened in advance based on their technological capabilities, supply capacity, and other relevant traits; however, the possibility of delivery delays, product defects and other production-side risks stemming from outsourcers cannot be ruled out completely. In particular, inadequate production capacity among outsourcers could result in the Group being unable to supply enough products amid periods of high product demand.

19. Product Quality Although the Group makes an effort to improve the quality of semiconductor products, they may contain defects, anomalies or malfunctions that are undetectable at the time of shipment due to increased sophistication of technologies and the diversity of ways in which the Group's products are used by customers. These defects, anomalies or malfunctions could be discovered after the Group products were shipped to customers, resulting in the return or exchange of the Group's products, claims for compensatory damages, or discontinuation of the use of the Group's products, which could negatively impact the profits and operating results of the Group. To prepare for such events, the Group has insurance such as product liability insurance and recall insurance, but it is not guaranteed that the full costs of reimbursements would be covered by these.20. Product Sales a. Reliance on Key Customers The Group relies on certain key customers for the bulk of its product sales to customers. The decision by these key customers to cease adoption of the Group's products, or to dramatically reduce order volumes, could negatively impact the Group's operating results. b. Changes in production plans by customers of custom products The Group receives orders from customers for the development of specific semiconductor products in some cases. There is the possibility that after the Group received orders the customers decide to postpone or cancel the launch of the end products in which the ordered product is scheduled to be embedded. There is also the possibility that the customers cancel its order if the functions and quality of the product do not meet the customer requirements. Further, the weak sales of end products in which products developed by the Group are embedded may result in customers to reduce their orders, or to postpone delivery dates. Such changes in production plans, order reductions, postponements and other actions from the customers concerning custom products may cause declines in the Group sales and profitability. c. Reliance on Authorized Sales Agents In Japan and Asia, the Group sells the majority of its products via independent authorized sales agents, and relies on certain major authorized sales agents for the bulk of these sales. The inability of the Group to provide these authorized sales agents with competitive sales incentives or margins, or to secure sales volumes that the authorized sales agents consider appropriate, could result in a decision by such agents to replace the Group products handled with those of a competitor, which could cause a downturn in the Group sales.

21. Securing Human Resources The Renesas Group works hard to secure superior human resources for management, technology development, sales, and other areas when deploying business operations. However, since such superbly talented people are of limited number, there is fierce competition in the acquisition of human resources. Under the current conditions, it may not be possible for the Group to secure the talented human resources it requires.22. Retirement Benefit Obligations The retirement benefit obligations and prepaid pension expenses that the Group budgets are calculated based on actuarial assumptions, such as discount rates and expected rates of returns on assets. However, the Group performance and financial condition may be adversely affected either if discrepancies between actuarial assumptions and business performance arise due to changing interest rates or a fall in the stock market and retirement benefit obligations increase or our pension assets decrease and there is an increase in the pension funding deficit in the retirement benefit obligations system.

23. Impairment Loss on Fixed Assets The Group has recorded tangible fixed assets and many other long-lived assets in its consolidated balance sheet, and when there is an indicator of impairment loss, the Group reviews whether it will be able to recover the recorded residual value of these assets in the form of future cash flows generated by these assets. If these assets do not generate sufficient cash flows, the Group may be forced to recognize impairment loss in their value.24. Information Systems Information systems are growing importance in the Group's business activities. Although the Group makes an effort to manage stable operation of information systems, there is a likelihood that customer confidence and social trust would deteriorate, resulting in a negative effect on the Group's performance, if there is a significant problem with the Group's information systems caused by factors such as natural disasters, accidents, computer viruses and unauthorized accesses.25. Information Management The Group has in its possession a great deal of confidential information and personal information relating to its business activities. While such confidential information is managed according to law and internal regulations specifically designed for that purpose, there is always the risk that information may leak due to unforeseen circumstances. Should such an event occur, there is a likelihood that customer confidence and social trust would deteriorate, resulting in a negative effect on the Group's performance.26. Legal Restrictions The Group is subject to a variety of legal restrictions in the various countries and regions in which we operate. These include requirements for approval for businesses and investments, export restrictions, customs duties and tariffs, accounting standards and taxation, and environment laws. Moving forward, it is possible that Renesas Group businesses, performance, and financial condition may be adversely affected by increased costs and restrictions on business activities associated with the strengthening of local laws.27. Environmental Factors The Group strives to decrease its environmental impact with respect to diversified and complex environmental issues such as global warming, air pollution, industrial waste, tightening of hazardous substance regulation, and soil pollution. There is the possibility that, regardless of whether there is negligence in its pursuit of business activities, the Group could bear legal or social responsibility for environmental problems. Should such an event occur, the burden of expenses for resolution could potentially be high, and the Group could suffer erosion in social trust.28. Intellectual Property While the Group seeks to protect its intellectual property, it may not be adequately protected in certain countries and areas. In addition, there are cases that the Group's products are developed, manufactured and sold by using licenses received from third parties. In such cases, there is the possibility that the Group could not receive necessary licenses from third parties, or the Group could only receive licenses under terms and conditions less favorable than before.29. Legal Issues As the Group conducts business worldwide, it is possible that the Group may become a party to lawsuits, investigation by regulatory authorities and other legal proceedings in various countries. In particular, the Group is at present the subject of investigation by regulatory authorities and is a defendant in civil lawsuits related to possible violations of antitrust law in several countries and areas. Although the Group's subsidiary in the U.S. had been named in Canada as one of the defendants in multiple civil lawsuits related to possible violations of competition law involving DRAM brought by purchasers of such products, the subsidiary has reached a settlement with the plaintiffs. The Group has been named in Canada as one of the defendants in multiple civil lawsuits related to possible violations of competition law involving SRAM brought by purchasers of such products. Although the Group had been named in Canada as one of the defendants in multiple civil lawsuits related to possible violations of competition law involving flash memory brought by purchasers of such products, the plaintiffs have withdrawn such multiple civil lawsuits. The Group's subsidiaries in the U.S., Europe and South Korea are the subject of investigations each by the U.S. Department of Justice, the Competition Bureau of Canada, the European Commission, and the Korea Fair Trade Commission in connection with possible violations of antitrust law/competition law related to thin-film transistor liquid crystal displays (TFT-LCDs). Among those, the European Commission imposed a fine on multiple TFT-LCD manufacturers in December 2010. However, the subsidiary of the Group has not been treated as a subject in the procedures. The Group's subsidiary in the U.S. has been named in the U.S. as one of the defendants in multiple civil lawsuits related to possible violations of antitrust law involving TFT-LCDs brought by purchasers of such products. The Group is the subject of an investigation by the European Commission regarding possible violations of competition law in relation to smartcard chips. It is difficult to predict the outcome of the legal proceedings to which the Group is presently a party or to which it may become a party in future. The resolution of such proceedings may require considerable time and expense, and it is possible that the Group may be required to pay compensation for damages, possibly resulting in significant adverse effects to the business, performance, and financial condition of the Group.Financial RiskFinancial risk is an umbrella term for multiple types of risk associated with financing, including frinancial transactions that include company loans in risk of default. Risk is a term often used to imply downside risk, meaning the uncertainty of a return and the potential for financial loss. In addition to financial risks, there are five broad categories of investment risks known as five risks.A science has evolved around managing market and financial riskunder the general title of modern portfolio theory initiated byDr. Harry Markowitz in 1952 with his article, "Portfolio Selection".In modern portfolio theory, the variance (or standard deviation) of a portfolio is used as the definition of risk.Financial risk is endogenous due in large part to the reasoning embedded in the opening quote. Endogenous risk refers to risks that are generated and amplified within the financial system, rather than risks from shocks that arrive from outside the financial system. The precondition for endogenous risk is the conjunction of circumstances where individual actors react to changes in their environment and where those individuals actions affect their environment. As we will see in the course of these lectures, the financial system is the supreme example of an environment where individuals react to whats happening around them and where their actions drive the realized outcomes themselves.Types of risk1.Asset-backed risk:Risk that the changes in one or more assets that support an asset-backed security will significantly impact the value of the supported security. Risks include interest rate, term modification, and prepayment risk.

2.Credit risk:The potential that a bank's borrower or counterparty will fail to meet its obligations in accordance with agreed terms. Credit risk, also called default risk, is the risk associated with a borrower going into default (not making payments as promised). Investor losses include lost principal and interest, decreased cash flow, and increased collection costs. An investor can also assume credit risk through direct or indirect use of leverage. For example, an investor may purchase an investment using margin. Or an investment may directly or indirectly use or rely on repo, forward commitment, or derivative instruments.3.Foreign investment risk:Risk of rapid and extreme changes in value due to: smaller markets; differing accounting, reporting, or auditing standards; nationalization, expropriation or confiscatory taxation; economic conflict; or political or diplomatic changes. Valuation, liquidity, and regulatory issues may also add to foreign investment risk.4.Liquidity risk:Liquidity is the ability to fund increases in assets and meet obligations as they become due. It is crucial to the ongoing viability of any organization. This is the risk that a given security or asset cannot be traded quickly enough in the market to prevent a loss (or make the required profit). There are two types of liquidity risk.Liquidity is the ability of a bank to fund increases in assets and meet obligations as they come due. The fundamental role of banks in the maturity transformation makes banks inherently vulnerable to liquidity risk. Every financial transaction or commitment has implications for a banks liquidity. Liquidity shortfall at a single institution can have system- wide repercussions5.Asset liquidity:An asset cannot be sold due to lack of liquidity in the market - essentially a sub-set of market risk. This can be accounted for by:Widening bid-offer spreadMaking explicit liquidity reservesLengthening holding period for VaR calculationsFunding liquidity - Risk that liabilities:Cannot be met when they fall dueCan only be met at an uneconomic priceCan be name-specific or systemic6.Market risk:The risk that movements in market prices will adversely affect the value of on- or off-balance sheet positions. The risk is attributable to movements in interest rates, foreign exchange (FX) rates, equity prices or prices of commodities.The four standard market risk factors are equity risk, interest rate risk, currency risk, and commodity risk: Equity risk is the risk that stock prices in general (not related to a particular company or industry) or the implied volatility will change. Interest rate risk is the risk that interest rates or the implied volatility will change. Currency risk is the risk that foreign exchange rates or the implied volatility will change, which affects, for example, the value of an asset held in that currency. Commodity risk is the risk that commodity prices (e.g. corn, copper, crude oil) or implied volatility will change.

7. Operational risk:Risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. The definition includes legal risk, but excludes reputational and strategic risk. Other risks Reputational risk Legal risk IT risk8. Diversification (finance)Financial risk, market risk, and even inflation risk, can at least partially be moderated by forms of diversification.The returns from different assets are highly unlikely to be perfectly correlated and the correlation may sometimes be negative. For instance, an increase in the price of oil will often favour a company that produces it,but negatively impact the business of a firm such an airline whose variable costs are heavily based upon fuel. However, share prices are driven by many factors, such as the general health of the economy which will increase the correlation and reduce the benefit of diversification. If one constructs a portfolio by including a wide variety of equities, it will tend to exhibit the same risk and return characteristics as the market as a whole, which many investors see as an attractive prospect, so that index funds have been developed that invest in equities in proportion to the weighting they have in some well known index such as the FTSE.However, history shows that even over substantial periods of time there is a wide range of returns that an index fund may experience; so an index fund by itself is not "fully diversified". Greater diversification can be obtained by diversifying across asset classes; for instance a portfolio of many bonds and many equities can be constructed in order to further narrow the dispersion of possible portfolio outcomes.A key issue in diversification is the correlation between assets, the benefits increasing with lower correlation. However this is not an observable quantity, since the future return on any asset can never be known with complete certainty. This was a serious issue in the Late-2000s recession when assets that had previously had small or even negative correlations suddenly starting moving in the same direction causing severe financial stress to market participants who had believed that their diversification would protect them against any plausible market conditions, including funds that had been explicitly set up to avoid being affected in this way.Diversification has costs. Correlations must be identified and understood, and since they are not constant it may be necessary to rebalance the portfolio which incurs transaction costs due to buying and selling assets. There is also the risk that as an investor or fund manager diversifies their ability to monitor and understand the assets may decline leading to the possibility of losses due to poor decisions or unforeseen correlations.9. Hedging:Hedging is a method for reducing risk where a combination of assets are selected to offset the movements of each other. For instance when investing in a stock it is possible to buy an option to sell that stock at a defined price at some point in the future. The combined portfolio of stock and option is now much less likely to move below a given value. As in diversification there is a cost, this time in buying the option for which there is a premium. Derivatives are used extensively to mitigate many types of risk.[11]

10. Financial / Credit risk related acronyms:ACPM Active credit portfolio managementEAD Exposure at defaultEL Expected lossERM Enterprise risk managementLGD Loss given defaultPD Probability of defaultKMV quantitative credit analysis solution developed by credit rating agency Moody'sVaR value at risk, a common methodology for measuring risk due to market movements

SOURCES OF FINANCIAL RISK:Apart from traditional types of loans, credit risk can also be found in a bank's: Investment portfolio Overdrafts Letters of credit Financial risk also exists in a variety of bank products, activities, and services, such as: Derivatives Foreign exchange Cash management services Trade financing

BEST PRACTICE IN MANAGEMENT OF FINANCIAL RISK:A. An appropriate financial risk environmentB. Operating under a sound finance granting processC. Appropriate finance administration, measurement and monitoring processD. Adequate controls over finacial riskEXTERNAL AND INTERNAL FACTORS OF FINANCIAL RISK:Effective financial management is a key to success for any small business. Business owners must be adept at balancing income, expenses and debt in a way that ensures the financial sustainability and growth of the organization. Being aware of external and internal factors of financial risk is vital to mastering the art and science of financial management.1.Economic Risks:Companies are exposed to financial risk from various aspects of the overall economy. Weakness in the economy, specific markets, industries or demographic groups can cause sudden drops in demand for particular goods or services, leaving small businesses with less money than they had anticipated. Negative shifts in demand can cause prices to drop across entire industries, putting all businesses at risk by quickly lowering profit margins and weakening income statements. Economic risk factors are uncontrollable from within an organization. Creative companies find ways to adapt their product offerings and business models to changing economic conditions, and are able to pay their debts and obtain new financing on a consistent basis.2.Receivables:The strength of a company's business customers determines the reliability of accounts receivable payments. If a major client closes its doors or refuses to pay its bills, your business could find itself unable to meet its own current obligations. This can pose a serious financial risk for businesses that rely on prompt receivables payments to meet their own current expenses. If your business model brings in both up-front payments and receivables, keep the proportion of your up-front business large enough to meet current expenses in case receivables turn sour for a month or two. If your business relies completely on receivables, build up a cash reserve dedicated to meeting up to three months' current expenses to stay afloat in case of non-payment issues.

3.Legal Risks:Changes in tax laws and industry regulations can eat into small businesses' profit margins. Companies might find themselves unable to meet debt obligations due to large unforeseen expenses, such as the mandatory installation of new safety systems or a hefty tax on carbon emissions. New laws can even push companies out of business entirely, such as when popular pharmaceuticals or food products are banned by a government authority. In the case of regulatory and tax changes, keeping enough cash on hand to cover unforeseen obligations and remaining aware of expected tax changes can help reduce the risk of default. In the case of banned products, companies must be adaptable enough to change products or business models quickly to survive.4. Performance Risks:The risk of failure cannot be discounted when considering financial risk factors. Sole proprietors take on personal liability for all company financing; if the company closes its doors, the business owner can find himself in serious financial trouble, possibly resulting in personal bankruptcy. The risk of failure is an ever-present reality that entrepreneurs must face with confidence and caution.Aside from outright failure, a companys income statements may turn out weaker than expected in a given quarter or year, leaving it with less money to repay debts, and weaker valuations to show to lenders. A number of factors can cause weaker-than-expected performance; new competition, quality issues and ineffective planning are just a few.Factors of financial risk:There is no "right" or "wrong" when it comes to your individual attitude toward risk. It's important, however, to be aware of your feelings in order to work within your own comfort zone. There are five general categories of risk tolerance. They are:1.Very conservative:These investors tend to like investments that are less likely to fluctuate in volatile markets and will forgo potentially higher rates of return in exchange for safety of principal. For example, retirees who are concerned about the impact of a market downturn on their ability to comfortably take retirement income typically prefer a very conservative portfolio.2.Conservative:These investors will tolerate some risk as they seek a reasonable rate of return. Investors who are nearing retirement tend to move toward more conservative portfolios.3.Moderate:These investors tend to like a balanced portfolio of lower risk and higher risk investments.4.Aggressive:These investors are more likely to be comfortable with higher levels of risk for potentially higher levels of return. They tend to have investment goals with longer time horizons.5.Very aggressive:These investors are willing to take a significant amount of risk for potentially higher returns. For example, young people who do not need access to their portfolio holdings for a long period of time may be more comfortable with very aggressive portfolios.Contributing factors to the emergence of risk in financial markets and implications for risk governance:With respect to contributing factors to risk emergence, the most relevant ones for financial transactions and markets are information asymmetries, technological advances (financial product innovation), social dynamics,(globalization, attitudes toward risk), conflicts about interests (competing economic interests) and varying susceptibilities to risk. All of these factors operate in a context of a very complex, global financial system.

In addition to validating the main concepts proposed by IRGC, the paper highlights a few implications of the analysis for risk governance. It also offers one specific suggestion, that of introducing an overarching concept of sound risk governance as alignment of all relevant stakeholders around an acceptable risk profile. The potential implications of such an approach to addressing contributing factors to emerging risks are briefly illustrated for further consideration and research.

I. CONTRIBUTING FACTORS TO EMERGING RISKS IN FINANCIAL MARKETS:Self-hazardous behaviour (where the same person who generates the risk bears the risk), cogeneratedrisks (where two or more agents engage in decision-making that creates risk incurred by at least one of them) and external risks (where the risk generator has no formal relationship with the risk bearer) arise frequently in financial transactions between individuals and financial institutions on the one hand as well as between institutions in financial markets on the other hand.a) Information asymmetries and varying susceptibilities to risk:The use of financial products and services requires a modicum of knowledge and familiarity with their costs, benefits and increasingly some basic understanding of the potential risks associated with them. This is the case even for basic transaction products such as bank accounts or debit and credit cards, let alone for more complex products such as mortgages, investment portfolios, retirement plans and insurance policies .Yet, despite the progress achieved in enhancing financial literacy over the past couple of decades, there remains an uneven playing field in terms of significant information asymmetries between the suppliers of many financial products and the individual consumers who buy and use them. Clearly, this is not a new or surprising phenomenon and most financial institutions endeavour on a regular basis to minimise these information asymmetries in a variety of ways including explicitly assessing with clients the suitability of particular products to their specific circumstances. When conducted properly, suitability testing covers not only the knowledge component but it also addresses varying susceptibilities to potentially adverse outcomes and the willingness and capacity of the client to tolerate and cope with these outcomes. In common parlance, such tests help classify potential clients into several categories ranging at one extreme from widows & orphans (relatively ill-informed and typicallyrisk averse) to the other extreme, namely professional investors (well-informed and generally ready, willing and able to take significant risk).Despite these efforts, however, the recent sub- prime mortgage crisis illustrates the significant adverse consequences of the triple nexus from which this particular risk emerged, namely: information asymmetry between borrowers on the one hand and mortgage brokers and providers on the other hand, insufficient knowledge on the part of many borrowers about key features of the mortgage product and, in many cases, a higher than anticipated degree of susceptibility to repricing refinancing risk at mortgage renewal time. While the bulk of these outcomes falls within the category of unintended risks (a combination of the self-hazardous behaviour, co-generated and external risks described above), there is evidence that some of these outcomes were the result of deliberate fraud on the part of some mortgage providers or brokers (contributing factor # 12, malicious attacks > motives for such fraud are most often rooted in greed, but attempts to cause others financial loss may also be due to envy, revenge or hatred). The mechanisms involved in these cases of deception/fraud vary but they generally involve some combination of the following elements: failure to disclose all relevant terms/conditions (thus exacerbating natural information asymmetries), exploiting knowledge gaps and severely understating or ignoring susceptibility to re-financing and other risks.The same fundamental nexus observed in the individual financial transaction context has also been evident as a contributing factor to emerging risk in the institutional financial interaction setting. A recent example of information asymmetries and knowledge variability at work relates to the evolution of securitised products over the past few years, both within and across national borders. In this context, the parties involved in a typical securitisation include several different institutions: originators/issuers of securities, underwriters who structure and package them, rating agencies which provide an opinion on the risk associated with these securities, intermediaries who sell them, end-investors who buy them to hold in their investment portfolios and other financial intermediaries who specialise in trading in and out of them for profit. The significant knowledge gaps and the extensive variability of access to accurate information across this lengthy chain of financial intermediation proved to be a major contributor to the recent demise of this asset class (particularly its cross-border component) after several years of impressive growth and apparent profitability.Here again, this is mostly a case of unintended emerging risk. However, there have also been several well-publicised cases of deliberate fraud by hedge funds which succeeded in defrauding even institutional counterparties and professional investors.b) Moral hazard and asymmetric incentive structures:The issue of moral hazard in financial behaviour and decision-making is a well-documented and extensively researched phenomenon. The insurance and re-insurance industries have devoted considerable resources over several decades to minimise the incidence of moral hazard through a variety of mechanisms designed to contain its impact as a driver of emerging risk. In contrast, moral hazard has continued to generate significant co-generated and external risks in the investment banking and asset management industry. This has become quite evident after the financial crisis of 2007 and 2008. While these risks materialise in a variety of ways (e.g. as unexpected losses on highly-rated collateralised debt obligations), they tend to share the following underlying dynamics: incentive structures are not symmetrical with respect to gain or loss for the party engaged in a given financial transaction or interaction (e.g. expected gain is far larger than potential loss) financial behaviour by individuals and/or institutions is accordingly distorted and typically skewed toward a higher risk appetite than would otherwise be the case as a consequence, additional external risks are generated and these are transferred, often implicitly, to third parties often without their full knowledge or explicit consent. The risk transfer can be intended or unintended, but the ease with which it shifts from the risk generators to the ultimate risk bearers is primarily a function of the contributing factors identified under paragraph a. above and of system complexity.c) System complexity:The report emphasised the importance of the systems perspective and of recognising complexity when considering the factors that contribute to the amplification or attenuation of emerging risks. In the financial markets context, system denotes: the network of financial transactions and interactions involving individuals and institutions operating within and across national borders the explicit or formal legal, regulatory and governance framework around these financial transactions and interactions and the implicit, usually informal rules of the game espoused by policy-makers which influence the expectations and hence the financial behaviour of individuals and institutions. System complexity relates not only to each of the three components of the system but also to the interdependence between them. To illustrate, one could argue that the scale and connectivity of an increasingly global financial network can provide a degree of resilience by spreading and dampening shocks across a larger market space. However, the system as a whole can nevertheless become fragile (and prone to major failure) if:- there are gaps in the explicit cross-border regulatory framework governing the networks operation following a particular type of shock, or- if there is a major difference between what the authorities were expected to do in reaction to that shock pursuant to the formal regulatory framework in place and the likely reaction of policy-makers as individual investors and financial institutions now anticipate it to be.The potential effect of such gaps and disconnects could be to introduce a significant new source of uncertainty about the stability of the system, with financial market participants wondering whether or not they are facing an underlying structural shift to a new systemic regime. It may accordingly prove analytically fruitful to think of the impact of system complexity along two distinct dimensions:- complexity within a system viewed as a stationary regime- versus complexity induced by expectations of the system potentially undergoing a regime shift.d) Unintended consequences of public policyPublic policy has historically shaped the bulk of the infrastructure of the modern financial system including payment, settlement and intermediation services. In addition, public policy (broadly defined to encompass monetary, fiscal and regulatory interventions) continues to exert a multifaceted impact on financial transactions and financial interactions, both in the domestic and the international arenas. In each country, central bankers, finance ministers and financial regulators are charged with the primary responsibility to maintain the safety and soundness of the domestic financial system. As a result, their interventions (actual and potential) in the markets, their expertjudgments (explicitly stated or inferred) about market trends and even their tacit endorsement of particular financial practices can and regularly do have a significant impact on the expectations and behaviour of financial market participants.In most cases, the well-intentioned policy stance of central bankers and financial regulators is generally effective in facilitating the achievement of public policy objectives. However, in the presence of information asymmetries, moral hazard and unappreciated system complexity (particularly in a globalised context), public policy can also on occasion have adverse, unintended consequences which can exacerbate the de-stabilising impact of other risk drivers, especially across borders. A recent case in point is the period from about 2002 until late 2006 where many financial market participants came to share, alongside with prominent policy-makers, the following set of related beliefs about the state of the financial system:- the financial system is inherently stable, robust and resilient (hence the frequent references to the era of great moderation)- modern financial instruments (e.g. securitisation products and credit derivatives) have succeeded in diversifying and dispersing risk to a significant extent; accordingly, shocks are expected to have effects of less than proportional magnitude- the complexity and opacity of many financial products and, correspondingly, of the poorly-understood interactions between the financial institutions who transact in them, are a benign side effect of innovation, an acceptable by-product in view of the resulting efficiency and productivity benefits.- ample and readily available credit can be taken for granted in the financial system since, in a downside stress scenario, the monetary authorities will be providing liquidity at a reasonably low cost (the Greenspan put)- in a worst case, systemic crisis scenario, large financial institutions, especially those that are too big or too interconnected to be allowed to fail, are likely to be rescued by the authorities.Some of these beliefs were borne out in the course of the financial crisis which started in 2007 and others have not been, at least to-date. One relevant lesson to learn from this episode is that pervasive information asymmetries and unmitigated moral hazard in a complex, poorly understood system can, in combination, become major contributing factors to the emergence of risk, particularly when the public policy stance is widely perceived as accommodating or complacent.Such outcomes arising at the tail end of a long cross-border chain of events can appear counterintuitive and disproportional, but they illustrate vividly the difficulty of identifying and quantifying causal links between a multitude of potential causal agents and specific observed effects (IRGCs definition of complexity). In the same vein as the story connecting a hurricane to the flapping of a butterflys wings, is it implausible that the imprudent sub-prime mortgages offered to less than creditworthy borrowers in California and Florida circa 2005 could have been a contributing factor to the losses incurred in Icelands banking system in 2008?II. Main amplifiers and attenuators or emerging risks in financial marketsa) Risk amplifiers Unrecognised concentrations and interdependenciesMost financial institutions (especially major insurance and reinsurance companies) realise that hidden concentrations are the Achilles heel which can severely undermine the sustainability of their business model. Undetected accumulations of similar (or highly positively correlated) exposures can in the extreme prove fatal in a business where it is critical to measure risk correctly, price for it accordingly and ensure that pricing for risk remains actuarially fair over time.Clearly, this is easier said than done within each insurance or banking institution, particularly in an environment characterised by:- a fast pace of product innovation and diffusion of new products- increasing customisation of financial products and services (which typically create complex embedded options)- high and variable volatility in market values- and the proliferation of hedging instruments which help in mitigating some measurable risk but often at the cost of incurring other indirect or contingent exposures which are far harder to measure.The task facing central bankers and financial regulators is even more difficult since it involves probing for unrecognised concentrations and interdependencies within the system as well as at the level of each one of the systemically-important institutions. The collective failures of financial institutions observed over the past couple of years vary in terms of the particular types of asset concentrations, liability mismatches or off-balance sheet exposures which went undetected until a specific risk emerged. However the underlying amplification mechanism is a common one: an initial, seemingly minor shock to the visible tip of the iceberg above the surface is transmitted to the much larger, heretofore invisible mass of the iceberg below the surface; this results in unexpectedly large adverse impacts which appear prima facie out of proportion to the initial shock. However, such impacts can often be rationalised ex post once the scale of the exposure concentration and the transmission mechanism connecting the dependencies become apparent. Early warning systems focused on this particular amplifier can help mitigate the large chance thatthe risks will materialize with maximum impact.

LEVERAGEIn finance, leverage is a general term for any technique to multiply gains and losses. Most often it involves buying more of an asset by using borrowed funds, with the belief that the income from the asset or asset price appreciation will be more than the cost of borrowing. Almost always this involves the risk that borrowing costs will be larger than the income from the asset or the value of the asset will fall, leading to incurred losses.Source Individuals leverage their savings when buying a home by financing a portion of the purchase price with mortgage debt. Individuals leverage their exposure to financial investments by borrowing from their broker. Securities like options and futures contracts are bets between parties where the principal is implicitly borrowed/lent at very short t-bill rates. Equity owners of businesses leverage their investment by having the business borrow a portion of its needed financing. The more it borrows, the less equity it needs, so any profits or losses are shared among a smaller base and are proportionately larger as a result.[3] Businesses leverage their operations by using fixed cost inputs when revenues are expected to be variable. An increase in revenue will result in a larger increase in operating income. Hedge funds may leverage their assets by financing a portion of their portfolios with the cash proceeds from the short sale of other positions.While leverage magnifies profits when the returns from the asset more than offset the costs of borrowing, losses are magnified when the opposite is true. A corporation that borrows too much money might face bankruptcy or default during a business downturn, while a less-levered corporation might survive. An investor who buys a stock on 50% margin will lose 40% of his money if the stock declines 20%.Risk may be attributed to a loss in value of collateral assets. Brokers may require the addition of funds when the value of securities hold declines. Banks may fail to renew mortgages when the value of real estate declines below the debt's principal. Even if cash flows and profits are sufficient to maintain the ongoing borrowing costs, loans may be called.This may happen exactly when there is little market liquidity and sales by others are depressing prices. It means that as things get bad, leverage goes up, multiplying losses as things continue to go down. This can lead to rapid ruin, even if the underlying asset value decline is mild or temporary.[6] The risk can be mitigated by negotiating the terms of leverage, by maintaining unused room for additional borrowing, and by leveraging only liquid assets.[7]On the other hand, the extreme level of leverage afforded in forex trading presents relatively low risk per unit due to its relative stability when compared with other markets. A standard unit of measurement known as a pip equals .0001 USD. Compared with other trading markets, forex traders must trade a much higher volume of units in order to make any considerable profit. For example, many brokers offer 100:1 leverage for investors, meaning that someone bringing $1,000 can control $100,000 while taking responsibility for any losses or gains their investments incur. This intense level of leverage presents equal parts risk and reward.There is an implicit assumption in that account, however, which is that the underlying levered asset is the same as the unlevered one. If a company borrows money to modernize, or add to its product line, or expand internationally, the additional diversification might more than offset the additional risk from leverage.[6] Or if an investor uses a fraction of his or her portfolio to margin stock index futures and puts the rest in a money market fund, he or she might have the same volatility and expected return as an investor in an unlevered equity index fund, with a limited downside.[7] Or if both long and short positions are held by a pairs-trading stock strategy the matching and off-setting economic leverage may lower overall risk levels.So while adding leverage to a given asset always adds risk, it is not the case that a levered company or investment is always riskier than an unlevered one. In fact, many highly levered hedge funds have less return volatility than unlevered bond funds,[7] and public utilities with lots of debt are usually less risky stocks than unlevered technology companies.