• Financial risk includes market risk and credit risk.investment risks image by Pix by Marti from Fotolia.com
  
  Financial risk is the loss expectation arising from adverse security prices or a business partner's default. It is inherent in all economic activities, including transactions involving non-profit organizations, such as charitable institutions, academic entities and governments. Accounting principles require a company to record operating losses at fair (market) values in financial statements.
  
  

Quantitative Risk Management

• Quantitative financial risk management tools involve mathematical and statistical concepts. A quantitative risk manager uses complex econometric formulas and computer algorithms to detect, appraise and monitor financial risks in corporate transactions. These quantitative tools include VaR (value at risk), Monte Carlo simulation and stress testing. Financial risk include losses due to unfavorable changes in commodity and security prices as well as negative variations in currency and interest rates. A company often hires a specialist, such as a university statistician, to help develop quantitative financial risk management tools.
  
  

Risk and Control Assessment

• Department heads and business unit managers periodically review corporate procedures and guidelines, and they prepare "risk and control self-assessment," or RCSA, reports. In an RCSA, a segment head usually documents internal controls and risks, and rates such risks as "high," "medium" and "low," depending on the loss expectation. Senior managers usually focus on "high" and "medium" risks and provide corrective measures for those risks. Segment staff members partner with internal auditors to find appropriate solutions to "low" risks, in accordance with generally accepted auditing standards, or GAAS. Regulators, such as the Securities and Exchange Commission and the Public Company Oversight Board, often require a company to include RCSA reports in regulatory filings.
  
  

Insurance Coverage

• Financial risk insurance coverage helps a firm prevent significant losses in market or credit transactions. This type of protection can often be critical in transactions involving international business partners because currency and political risks increase potential losses. For instance, a bank signs a currency swap (exchange) agreement with a foreign business partner. The bank expects to receive the equivalent of $10 million in three months. The company's financial risk manager buys a 95 percent coverage to prevent losses. Two months later, the foreign business partner files for bankruptcy. The bank incurs only $500,000 in losses because it receives $9.5 million ($10 million times 95 percent) in insurance proceeds.
  
  

Financial Risk Audit

• A company's internal audit department performs periodic reviews of internal controls and policies to ensure such controls are adequate and functional. A financial risk auditor focuses on accounting and reporting systems to ensure that financial statements are accurate and complete. A complete set of financial statements include a balance sheet (also called statement of financial position), statement of profit and loss (or P&L), statement of cash flows and statement of retained earnings.