Page 32 - RMAI Bulletin July 2024

RMAI BULLETIN JULY 2024

to pay their debt obligations, harming investors. Pros and Cons of Financial Risk
Changes in the market interest rate can push individual Pros:
securities into being unprofitable for investors, forcing
them into lower-paying debt securities or facing nega- Encourages more informed decisions.
tive returns. Helps assess value (risk-reward ratio).
Can be identified using analysis tools.
Asset-backed risk is the chance that asset-backed se-
curities-pools of various types of loans-may become Cons:
volatile if the underlying securities also change in Can arise from uncontrollable or unpredictable
value. Sub-categories of asset-backed risk involve the outside forces.
borrower paying off a debt early, thus ending the in-
come stream from repayments and significant changes Risks can be difficult to overcome.
in interest rates. Ability to spread and affect entire sectors or mar-
kets.
Financial Risk for Individual
Individuals can face financial risk when they make poor Tools to Control Financial Risk
decisions. This hazard can have wide-ranging causes Luckily there are many tools available to individuals,
from taking an unnecessary day off of work to invest- businesses, and governments that allow them to cal-
ing in highly speculative investments. Every undertak- culate the amount of financial risk they are taking on.
ing has exposure to pure risk-dangers that cannot be
controlled, but some are done without fully realizing The most common methods that investment profes-
the consequences. sionals use to analyse risk associated with long-term
investments-or the stock market as a whole-include:
Liquidity risk comes in two flavors for investors to fear. Fundamental analysis, the process of measuring a
The first involves securities and assets that cannot be security's intrinsic value by evaluating all aspects
purchased or sold quickly enough to cut losses in a of the underlying business including the firm's
volatile market. Known as market liquidity risk this is assets and its earnings.
a situation where there are few buyers but many sell-
ers. The second risk is funding or cash flow liquidity Technical analysis, the process of evaluating secu-
risk. Funding liquidity risk is the possibility that a cor- rities through statistics and looking at historical re-
poration will not have the capital to pay its debt, forc- turns, trade volume, share prices, and other per-
ing it to default, and harming stakeholders. formance data.
Quantitative analysis, the evaluation of the histori-
Speculative risk is one where a profit or gain has an cal performance of a company using specific finan-
uncertain chance of success. Perhaps the investor did cial ratio calculations.
not conduct proper research before investing, reached
too far for gains, or invested too large of a portion of For example, when evaluating businesses, the
their net worth into a single investment. debt-to-capital ratio measures the proportion of
debt used given the total capital structure of the

Investors holding foreign currencies are exposed to company. A high proportion of debt indicates a
currency risk because different factors, such as inter- risky investment. Another ratio, the capital expen-
est rate changes and monetary policy changes, can diture ratio, divides cash flow from operations by
alter the calculated worth or the value of their money. capital expenditures to see how much money a
Meanwhile, changes in prices because of market dif- company will have left to keep the business run-
ferences, political changes, natural calamities, diplo- ning after it services its debt.
matic changes, or economic conflicts may cause vola- In terms of action, professional money managers,
tile foreign investment conditions that may expose traders, individual investors, and corporate invest-
businesses and individuals to foreign investment risk. ment officers use hedging techniques to reduce

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