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Financial Risk Management
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  • Date: 02 Aug 2019
  • Finance
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Financial Risk is one of the significant concerns of every business. To understand the techniques of risk management, it is essential to realise the concept and types of risk. Risk is referred to like the chances of having an unexpected outcome. Any action that leads to loss of any type is termed as Risk. There are different types of risks that business firms can come across and needs to overcome. 

The risks can be mainly classified into the following models:

Business Risk: These types of risks are usually faced by business enterprises to maximise the profit and value of shareholder. As the companies undertake high-cost risks to launch the new product for enhancing the higher sales in the market.

Non- Business Risk: The risks that arise out of economic and political imbalances is defined as Non- Business Risk. Business firms cannot control these types of firms.

Financial Risk: Financial Risk is the risk that involves financial loss to the business firms. It generally arises due to the losses and instability in the financial market caused by changes in stock prices, interest rates, currencies and more.

Types of Financial Risks:

It is one of the high-priority kinds of risk in every business. Financial Risk is induced due to the movement in the market as it includes the gathering of various factors. Due to this, financial Risk can be classified into multiple types such as Credit Risk, Market Risk, Legal Risk, Liquidity Risk, and Operational Risk.

Credit Risk: When any firm fails to fulfil the obligations towards their counterparties, then it is called as Credit Risk. It can be classified into Sovereign Risk and Settlement Risk. Sovereign Risk arises due to difficulties in the policies of foreign exchange. Whereas, on the other hand, settlement risk occurs when one party makes the payment, and the other party fails to fulfil the obligations.

Market Risk: It arises due to the change in prices of financial instrument. It can be further classified as Directional (caused due to movement in stock price, interest rates, etc.) and Non-Directional Risk (volatility risks).

Legal Risk: This risk arises from legal constraints such as lawsuits and legal notices. Whenever a company faces the financial loses out of legal proceedings, it is a legal Risk.

Liquidity Risk: This risk arises out of an inability to execute the transactions in the market. It can be classified into Funding Liquidity Risk and Asset Liquidity Risk. Asset liquidity risk arises due to insufficient buyers or insufficient sellers against the buying and selling the orders.

Operational Risk: This risk arises due to operational failures such as technical failure and mismanagement. It can be further classified into Model risk and Fraud risk. It arises due to the lack of controls and model risk to the incorrect model application.

Stages in Financial Risk Management:

Identification of the risk: The risk can be managed by identifying the financial risk and the cause of the same. It is good to start with the balance sheet of the company as it specifies the liabilities, debt, risk of the rate of interest, exposure of foreign-exchange, etc. The cash flow statement and the income statement shall be observed to see how it fluctuates, and the impact of the same on the organisation.

Quantifying the exposure: It is necessary to analyse the risk or to put the numerical value of risk identified by the firm. The analysis can take place with the help of statistics such as the method of regression and standard deviation to measure the exposure of the company to various factors of risk.

Decision making: After analysing the source of risk, the firm should decide the way to deal with the risk. The decision should be made by taking into consideration the multiple factors such as the aim of the company,   business environment, its appetite and the cost of mitigation to reduce the risk.

To reduce the financial risk, the organization should reduce the volatility of the cash flow, fix the rate of interest on loans, manage the cost of operation, improvise the payment terms, exposure of the price of the commodity, variations in the price of raw materials.
  
The financial risk is usually managed by the owner or managers of the organisation. The organisation also take the consultation from the Financial Risk Manager to manage risk faced by them and to recommend the actions for the welfare of the company.

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Financial Risk Management

By: Finance 02 Aug 2019

Financial Risk is one of the significant concerns of every business. To understand the techniques of risk management, it is essential to realise the concept and types of risk. Risk is referred to like the chances of having an unexpected outcome. Any action that leads to loss of any type is termed as Risk. There are different types of risks that business firms can come across and needs to overcome. 

The risks can be mainly classified into the following models:

Business Risk: These types of risks are usually faced by business enterprises to maximise the profit and value of shareholder. As the companies undertake high-cost risks to launch the new product for enhancing the higher sales in the market.

Non- Business Risk: The risks that arise out of economic and political imbalances is defined as Non- Business Risk. Business firms cannot control these types of firms.

Financial Risk: Financial Risk is the risk that involves financial loss to the business firms. It generally arises due to the losses and instability in the financial market caused by changes in stock prices, interest rates, currencies and more.

Types of Financial Risks:

It is one of the high-priority kinds of risk in every business. Financial Risk is induced due to the movement in the market as it includes the gathering of various factors. Due to this, financial Risk can be classified into multiple types such as Credit Risk, Market Risk, Legal Risk, Liquidity Risk, and Operational Risk.

Credit Risk: When any firm fails to fulfil the obligations towards their counterparties, then it is called as Credit Risk. It can be classified into Sovereign Risk and Settlement Risk. Sovereign Risk arises due to difficulties in the policies of foreign exchange. Whereas, on the other hand, settlement risk occurs when one party makes the payment, and the other party fails to fulfil the obligations.

Market Risk: It arises due to the change in prices of financial instrument. It can be further classified as Directional (caused due to movement in stock price, interest rates, etc.) and Non-Directional Risk (volatility risks).

Legal Risk: This risk arises from legal constraints such as lawsuits and legal notices. Whenever a company faces the financial loses out of legal proceedings, it is a legal Risk.

Liquidity Risk: This risk arises out of an inability to execute the transactions in the market. It can be classified into Funding Liquidity Risk and Asset Liquidity Risk. Asset liquidity risk arises due to insufficient buyers or insufficient sellers against the buying and selling the orders.

Operational Risk: This risk arises due to operational failures such as technical failure and mismanagement. It can be further classified into Model risk and Fraud risk. It arises due to the lack of controls and model risk to the incorrect model application.

Stages in Financial Risk Management:

Identification of the risk: The risk can be managed by identifying the financial risk and the cause of the same. It is good to start with the balance sheet of the company as it specifies the liabilities, debt, risk of the rate of interest, exposure of foreign-exchange, etc. The cash flow statement and the income statement shall be observed to see how it fluctuates, and the impact of the same on the organisation.

Quantifying the exposure: It is necessary to analyse the risk or to put the numerical value of risk identified by the firm. The analysis can take place with the help of statistics such as the method of regression and standard deviation to measure the exposure of the company to various factors of risk.

Decision making: After analysing the source of risk, the firm should decide the way to deal with the risk. The decision should be made by taking into consideration the multiple factors such as the aim of the company,   business environment, its appetite and the cost of mitigation to reduce the risk.

To reduce the financial risk, the organization should reduce the volatility of the cash flow, fix the rate of interest on loans, manage the cost of operation, improvise the payment terms, exposure of the price of the commodity, variations in the price of raw materials.
  
The financial risk is usually managed by the owner or managers of the organisation. The organisation also take the consultation from the Financial Risk Manager to manage risk faced by them and to recommend the actions for the welfare of the company.
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All About Equated Monthly Installment (EMI)

By: admin Finance 25 Apr 2019

An EMI or Equated Monthly Installment is a fixed amount payment made by a borrower to a lender at a specified date of every month. The monthly instalments are used to pay off both the interest and the principal each month so that after the specified number of years, the loan is paid off in full."

The benefit of an EMI is that they know exactly how much money they will need to pay for their loan each month, making the personal budget process easier.

An EMI is a financial term used for loan repayments. It is a quick and easy method to pay off the loan. When a borrower takes a loan from the bank or Non-Banking Financial Company (NBFC), the repayment of the loan is done mainly in instalments. The fixed financial instalments are known as EMIs. The amount of EMI depends on the principal loan amount, tenure and the interest rate. This monthly instalment is supposed to be paid on a fixed date to the bank by cheque or by electronically. 

How EMIs work?

EMI is a fixed payment of amount every month as part repayment of a loan or a purchase. It constitutes the principal amount to be paid along with a certain rate of interest. The interest depends on the amount borrowed and the duration for which it is borrowed. The principal element is lesser than the interest element in the initial period of repayment and the rate of interest will decrease progressively and the principal amount will increase over the period of repayment.

How to calculate EMI?

EMI calculators require a few factors/parameters to produce the desired results.
- Loan amount
- Tenure period
- Interest Rate
- Processing Fee (If any)


Following are the few advantages and disadvantages of the EMI scheme 

Advantages:

Freedom of Buying Expensive Utilities: EMI gives a chance to buy expensive utilities which one won’t be able to buy. EMI helps you to buy anything and everything, be it expensive household items, a vehicle, gifts, jewellery or a house. The consumers get a chance to divide the amount in monthly instalments and pay it off easily.

Easy to Repay: The borrower can pay the loan in instalments by opting for EMI. The amount is decided on the basis of the principal loan amount, time, interest rate and the borrower’s capacity of repayment. EMI makes it easier for the borrowers to pay the said amount in small portions every month. Hence they don’t have to pinch their monthly expenses to afford various utilities.

Flexible EMI Options by Banks: Many banks nowadays offer various flexible EMI options to the borrowers. The EMIs are decided as per the borrower’s needs. The instalment and tenure are decided by the borrower as per his or her convenience.

Affordability: EMIs gives the consumers the freedom to afford things that they won’t be able to make complete payments for. It lets the consumer make payments in instalments allowing them the freedom to purchase which they can’t make lump-sum payments.

The absence of a Middleman: The EMI is directly paid to the lender and there are no hassles of a middleman.

Disadvantages:

Longer Duration of Debts: The borrowers have to pay the monthly instalments until they pay the principal amount and the amount of interest rate. In terms of a car loan or home loans, the tenure goes as long as 20 to 30 years. Which means a borrower spends almost half of his or her life repaying the loan. Which restricts the borrowers from buying any other utilities in.

No Early Repayment: If a borrower wants to pay back the loan earlier than actual duration by using extra savings or a bonus, banks do not offer an easy option to do so. Many banks and NBFCs charge an early repayment fee. Which makes it difficult further for borrowers to pay off the loan earlier even if they could.

Charges on missing EMIs: If a borrower misses or forgets to pay the EMI by the given date, the banks and NBFCs charge the borrower with late fees. Missing multiple EMIs may lead the borrower to face legal action and their collateral can be taken.

Extra Amount: The borrower has to pay an extra amount than the actual borrowed amount in the form of the interest rate. As the principal amount and interest rate are combined to form an EMI, the borrower can’t avoid paying this extra amount.

Additional Amount: Additional amount in terms of interest. One need not pay interest if the payment is made at once.

Penalty for Prepayment: Many institutions do not allow prepayment and in case they do there will be a serious penalty that one will have to bear for the prepayment.

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