Quick reference for exams and helpful for class presentations Risk and return - Financial management, types of risk https://youtu.be/y2W1qOIWu28

2. What is risk?
• Risk is defined in financial terms as the chance that an outcome or
investment's actual gains will differ from an expected outcome
or return. Risk includes the possibility of losing some or all of an
original investment.
• There are several types of risk and several ways to quantify risk for
analytical assessments.
• Risk can be reduced using diversification and hedging strategies.

3. Types of Financial Risk
• Every saving and investment action involves different risks and
returns.
• In general, financial theory classifies investment risks affecting asset
values into two categories: systematic risk and unsystematic risk.
• Investors are exposed to both systematic and unsystematic risks.

4. Systematic risks
• Systematic risks, also known as market risks, are risks that can affect
an entire economic market overall or a large percentage of the total
market.
• Market risk is the risk of losing investments due to factors, such
as political risk and macroeconomic risk, that affect the performance
of the overall market. Market risk cannot be easily mitigated through
portfolio diversification.
• Other common types of systematic risk can include interest rate risk,
inflation risk, currency risk, liquidity risk, country risk, and
sociopolitical risk.

5. Unsystematic risk
• Unsystematic risk, also known as specific risk or idiosyncratic risk, is a
category of risk that only affects an industry or a particular company.
• Unsystematic risk is the risk of losing an investment due to company
or industry-specific hazard. Examples include a change in
management, a product recall, a regulatory change that could drive
down company sales, and a new competitor in the marketplace with
the potential to take away market share from a company.
• Investors often use diversification to manage unsystematic risk by
investing in a variety of assets.

6. Other types of risk
• Business Risk: Business risk refers to the basic viability of a business—the
question of whether a company will be able to make sufficient sales and
generate sufficient revenues to cover its operational expenses and turn a
profit.
• Credit or Default Risk: Credit risk is the risk that a borrower will be unable
to pay the contractual interest or principal on its debt obligations.
• Country Risk: Country risk refers to the risk that a country won't be able to
honor its financial commitments.
• Foreign-Exchange Risk: When investing in foreign countries, it’s important
to consider the fact that currency exchange rates can change the price of
the asset as well. Foreign exchange risk (or exchange rate risk) applies to all
financial instruments that are in a currency other than your domestic
currency.

7. Other types of risk
• Interest Rate Risk: Interest rate risk is the risk that an investment's value
will change due to a change in the absolute level of interest rates, the
spread between two rates, in the shape of the yield curve, or in any other
interest rate relationship.
• Political Risk: Political risk is the risk an investment’s returns could suffer
because of political instability or changes in a country.
• Counterparty Risk: Counterparty risk is the likelihood or probability that
one of those involved in a transaction might default on its contractual
obligation.
• Liquidity Risk: Liquidity risk is associated with an investor’s ability to
transact their investment for cash.

8. Risk and Return
• In investing, risk and return are highly correlated. Increased potential
returns on investment usually go hand-in-hand with increased
risk. Different types of risks include project-specific risk, industry-
specific risk, competitive risk, international risk, and market
risk. Return refers to either gains and losses made from trading a
security.
• Diversification allows investors to reduce the overall risk associated
with their portfolio but may limit potential returns. Making
investments in only one market sector may, if that sector significantly
outperforms the overall market, generate superior returns, but
should the sector decline then you may experience lower returns
than could have been achieved with a broadly diversified portfolio.

9. The relation between risk and return
• The risk-return tradeoff states the higher the risk, the higher the
reward—and vice versa. Using this principle, low levels of uncertainty
(risk) are associated with low potential returns and high levels of
uncertainty with high potential returns.

10. Risk and return in financial management
Risk refers to the variability of possible returns associated with a
given investment. Risk, along with the return, is a major consideration
in capital budgeting decisions. The firm must compare the expected
return from a given investment with the risk associated with it.