Risk Taxonomy

Risk Taxonomy

1. External Risks

   • Financial Markets Risks
     • Stock Market Risk
       • Key business risk for financial firms where firm results are directly linked to the performance of their capital market investments Arise from price movements or changes in volatility
     • Interest Rate Risk
       • Risks that movements in interest rates change the values of bond or bond-like investment, creating loss
         • How movements in interest rate affect....
           • INVESTOR BEHAVIORS
             • ↑ interest rates → ↑ demand for fixed interest instruments, → ↓ downward pressure on prices of stocks and other assets, as demand moves away
             • Higher interest rates reduce the discretionary savings of individuals who need to borrow cash for loans and for mortgages. - On the other hand, low interest rates discourage saving and other investment
             • House prices and markets can become depressed, which has knock on effects on the economy as a whole
           • FIRMS
             • Without careful management,, the value of the liabilities may move less/more than the value of the supporting assets as rate change, potentially creating losses
               • Insurance companies and pension plans are particularly vulnerable because annuities and premiums payments streams are highly interest -sensitive
     • Exchange Rate Risk
       • Transaction Risk
         •  This is the risk arising when a firm has current contractual obligations specified in different currencies
           •  The firm is exposed to losses from exchange rate movements in the time period between entering a contract and settling it
             •  If a contract calls for a series of payments specified in non-domestic currency, then the transaction risk continues as long as the contracts are in force
       • Economic Risk
         •  This refers to a firm’s general economic exposure to exchange rate fluctuations
       • Translation Risk
         •  This arises from the requirements of financial reporting, for a firm with assets and liabilities designated in different currencies
     • Credit Risk
       • Market Credit Risk
         • Bond Default Risk
           • risk that a bond issuer is unable to repay some or all of the principal and interest on an outstanding loan
         • Credit Downgrade Risk
           • possible change in value of bond investments resulting from a change in the credit rating of the issuer
             •  The credit rating of a bond-issuing institution is determined by a credit-rating agency (e.g. S&P Moody’s) o Investment grade: AAA to BBB- o Sub-Investment grade: BB+ to C oDefault: D
               •  2 bonds with identical payment schedules will have different values if the issuing institutions have different credit ratings
               •  When a firm’s credit rating changes, the value of the outstanding bonds issued by that firm will fall, and this represents a credit risk to the bond holders
         • Sovereign Risk
           •  Sovereign risk is risk of full or partial default by a country. 
             • Full Default
               • occurs when a country refuses to meet any interest or principal payments due on government bonds
                 • o The most common reason for full default is revolutionary regime change, where the incoming government rejects the obligations of the outgoing regime
             • Partial Default
               • occurs where a nation faces such severe economic stresses that it is unable to collect sufficient revenue to make the payments due on its loans
           •  Sovereign risk also cover situations where a country changes rules specifically for foreign investors
         • Credit Default Risk
           • risk that a debtor is unable to repay some or all of the amount owed
         • Counterparty Risk
           • risk that a counterparty fails to meet its obligations, whether through default or for other reasons
             •  Counterparty risk may be associated with concentration risk, which arises if the enterprise is heavily dependent on a single counterparty, or a mall set of mutually dependent counterparties
     • Spread Risk
     • Systematic Risk
     • Liquidity Risk
   • Political & Regulatory Risks
   • Macro Economic Risks
     • Business cycles
     • Inflation risk
   • Environmental Risks

2. Internal Risks

   • Operational Risk
     • IT Risk
     • People Risk
     • Project Risk
     • Legal Risk
     • Pricing Risk
   • Strategic
   • Reputational