BUSINESS RISK &

FINANCIAL RISK

AMAN AGRAWAL

Risk is the possibility of loss or injury , the degree or probability of such loss.

Actual Return different than Expected. Risk is directly related to expected return. Risk return-tradeoff

RISK

Wrong decision of what to Invest in Wrong timing of Investment Nature of instrument invested Creditworthiness of issuer Maturity period National and International factors

Causes of Risks

Degree of uncertainty associated with an Investments earnings and the Investments ability to pay the returns (Interest ,principal, dividends )owed Investors.

It is the portion of unsystematic risk caused by the operating environment of the business.

Inability to maintain competitive edge & stability of earnings.

 e.g., changes in tastes, preferences of consumers, strikes, increased competition, change in government policy, obsolescence etc .

Business risks may depends upon the nature and size of the business.

BUSINESS RISK

Strategic Risk: They are the risks associated with the operations of that particular industry. These kind of risks arise from◦ 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.

◦ Investor Relations: Strategy for communicating with individuals who have invested in the business.

Research and DevelopmentFixed costSingle product

Classification (Internal Risk)

Financial Risk: These are the risks associated with the financial structure and transactions of the particular industry.

Operational Risk: These are the risks associated with the operational and administrative procedures of the particular industry.

"the risk of a change in value caused by the fact that actual losses, incurred for inadequate or failed internal processes, people and systems, or from external events (including legal risk), differ from the expected losses". 

Compliance Risk(Legal Risk): These are risks associated with the need to comply with the rules and regulations of the government.

1) socio and regulatory factors 2) Political Risk 3) Business cycle Other risks: There would be different risks like

natural disaster(floods) and others depend upon the nature and scale of the industry.[8]

External Risk

Degree of uncertainty of payment resulting from a mix of debt and equity, the larger the proportion of debt financing, the greater the risk.

The use of debt with the owned fund to increase the return to the shareholder is called Financial Leverage.

Financial risk is an umbrella term for multiple types of risk associated with financing, including financial transactions that include company loans in risk of default.

Variance (or standard deviation) of a portfolio is used as the definition of risk.

Financial Risk

CREDIT RISK  refers to the risk that a borrower will default on a debt

by failing to make required payments.  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 and can arise in a number of circumstances……….

 payment due on a mortgage loan, credit card, line of credit, or other loan.

A company is unable to repay asset-secured fixed or floating charge debt.

A business does not pay an employee's earned wages when due.

A business or government bond issuer does not make a payment on a coupon

Insolvent bank won't return funds to a depositor.

Classification of Financial Risk

In the United States, a section on market risk is mandated by the SEC.2] in all annual reports submitted on Form 10-K. The company must detail how its own results may depend directly on financial markets.

Significant resources and sophisticated programs are used to analyze and manage risk. Some companies run a credit risk department whose job is to assess the financial health of their customers, and extend credit (or not) accordingly.

They may use in house programs to advise on avoiding, reducing and transferring risk. They also use third party provided intelligence. Companies like Standard & Poor's, Moody's, Fitch Ratings, DBRS, Dun and Bradstreet, Bureau van Dijk and Rapid Ratings International provide such information for a fee.

Currency risk

Interest rate risk

Equity Risk

Commodityrisk

Market risk is the risk of losses in

positions arising from movements in

market prices.

Market risk

Risk that a given security or asset cannot be traded quickly enough in the market to prevent a loss (or make the required profit).

Operational Risk Risk of a change in value caused by the fact that

actual losses, incurred for inadequate or failed internal processes, people and systems, or from external events (including legal risk), different from the expected losses". 

 Liquidity risk 

 Legal risk is the risk of loss to an institution which is primarily caused by:

Defective transaction Failing to take appropriate measures to protect assets

(for example, intellectual property) owned by the institution.

Change in law.

Volatility Risk  the risk of a change of price of a portfolio as a result

of changes in the volatility of a risk factor. It usually applies to portfolios of derivatives instruments, where the volatility of its underlyings is a major influencer of prices. Examples : Futures contracts

Legal Risk

Political risk  The prospect that government decisions will damage

the value of your investments. Whether it’s the safety of Social Security, and how it might affect stocks in your portfolio, tax-law changes or more, this is the chance that broad policy decisions hit home.

Macro political risks affect all participants in a given country. A common misconception is that macro-level political risk only looks at country-level political risk; however, the coupling of local, national, and regional political events often means that events at the local level may have follow-on effects for stakeholders on a macro-level

Well Balanced Group A

Dangerous Group

Conservative Group

Well Balanced Group B

CORRELAT BETWEEN BUSINESS RISK & FINANCIAL RISK

BUSINESS

RISK

F I N A N C I A L R I S K

LOW HIGH

LOW

HIGH

Financial leverage Use of the fixed-charges sources of funds, such as debt and preference capital along with the owners’ equity in the capital structure, is called as financial leverage

The financial leverage employed by a company is intended to earn more return on the fixed-charge funds than their costs. The surplus (or deficit) will increase (or decrease) the return on the owners’ equity.

Particulars

March 15 March 14 March 13 March 12

 Debt Equity Ratio 10.30 8.99 8.68 8.19 Debt to Owners

10.64 9.49 9.06 8.42

Debt Coverage Ratios 1.25 1.25 1.23 1.25Financial Charges Coverage ratio 1.25 1.26 1.23 1.25

Financial leverage (Lic housing finance)

The first two measures of financial leverage can be expressed either in terms of book values or market values. These two measures are also known as measures of capital gearing.The third & fourth measure of financial leverage, commonly known as coverage ratio. The reciprocal of interest coverage is a measure of the firm’s income gearing.

Operating Risk

Operating risk can be defined as the variability of EBIT (or return on total assets). The environment—internal and external—in which a firm operates determines the variability of EBIT◦ The variability of EBIT has two components:◦ variability of sales◦ variability of expenses

Financial risk

◦ The variability of EPS caused by the use of financial leverage is called financial risk. Financial risk is an avoidable risk if the firm decides not to use any debt in its capital structure.

particulars

March 15

March 14

VARIATION

SALES 10694.67 9214.71 16.06

EBIT 10429.53 9008.28 15.77

OPREATING RISK (LIC HOUSING FINANCE)

FINANCIAL RISK (LIC HOUSING FINANCE)

PATICULARS MARCH 15 MARCH 14 VARIATION

DEBT RATIO

10.30 8.99 14.57

EPS 27.47 26.10 5.24

RISK MANAGEMENT PROCESS

Change your business structure from a sole proprietorship to corporation or limited liability company where you have limited liability.

Transfer risk to insurance companies by insuring against major risks such as damage to your facilities, product liability, injuries to customers or suppliers and death or incapacity of company principals.

Evaluate the controls and reporting system by comparing actual practice and performance to the control procedures and the reported information.

Reduce financial risk by managing your accounts receivable to minimize outstanding balances and identify poor credit risks. Evaluate customer payments and ask for advance payment from customers who don't meet the standards.

Reduce financial risk by keeping outstanding loans and financing needs to a minimum. Control growth at a rate that the company can finance internally. If the company can't pay off some loans, replace short-term credit with long-term, fixed-rate loans

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