Risk and types of Financial Risk Essay -- Business, Banks, Insurance

Value at Risk-IntroductionAs Walter Wriston, former chairman of Citigroup, said All of life is the management of risk, not its elimination and nowadays mod banking is about controlling risk and returns. The ability of a fiscal institution to control risk is a key factor that determines its success or its ill in markets. As the late financial crisis has demonstrated institutions that were not properly prepared to face the crisis, failed and they were either bailed out by governments or serve economists as bad example. This is the reason risk management is an important field of every financial institution.-Risk and types of Financial RiskAs Philippe Jorion (2007) mentions a definition for risk throw out be the volatility of unanticipated outcomes and can be created by natural disasters, such(prenominal) as the recent earthquake in Japan that is reported to causality a drop of 3% of the oil price in the first few days after it, or it can created by human activities such as technolo gical innovation which might create unemployment. Phillip Best (1998) argues that risk matters only when it causes financial losses and financial risk is the unmatchable linked with financial assets and portfolios and is classified in broader categories market risk, credit risk, liquidity risk and operational risk. There is evidence that these types of risk can affect one another. Market risk is the one linked with the movements of the price level of market. Credit risk is generated when parties involved in an economic contract are either incapable or opposed to satisfy their commitments. Jorion (2007) classifies liquidity risk into two forms asset liquidity risk and funding liquidity risk. Jorion (2007, p. 23)Asset liquidity riskarises when a transaction can... ... effect than those expected. Nevertheless VaR is always a statistical tool, meaning that if using VaR is estimated a loss of 10 millions in one month, it is known that thither might be months with smaller losses and m onths with larger than 10 millions. There is also the problem of identifying the right method because each method has its own strengths and weaknesses.So it is important for a risk manager to be able to identify the key factors of the market. These can be market rates and prices that can affect the portfolio and the need of this derives from the fact that without these factors is impossible to build a proper quantitative measure of market risk, due to the complexity of financial markets. So to start properly one has to recognize the instruments through which market risk factors will be embodied, such instruments may be options, swaps or loans.