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Basis Risk
Basis risk in finance is the risk associated with imperfect hedging.[1] It arises because of the difference between the price of the asset to be hedged and the price of the asset serving as the hedge, or because of a mismatch between the expiration date of the hedge asset and the actual selling date of the asset (calendar basis risk), or—as in energy—due to the difference in the location of the asset to be hedged and the asset serving as the hedge (locational basis risk).Contents1 Definition 2 Examples 3 See also 4 References4.1 Notes 4.2 External linksDefinition[edit] Under these conditions, the spot price of the asset, and the futures price, do not converge on the expiration date of the future. The amount by which the two quantities differ measures the value of the basis risk
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Finance
Finance
Finance
is a field that deals with the study of investments. It includes the dynamics of assets and liabilities over time under conditions of different degrees of uncertainties and risks. Finance can also be defined as the science of money management. Market participants aim to price assets based on their risk level, fundamental value, and their expected rate of return
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Uncertainty
Related concepts and fundamentals:Agnosticism Epistemology Presupposition Probabilityv t eSituations often arise wherein a decision must be made when the results of each possible choice are uncertain. Uncertainty
Uncertainty
has been called "an unintelligible expression without a straightforward description".[1] It describes a situation involving ambiguous and/or unknown information. It applies to predictions of future events, to physical measurements that are already made, or to the unknown
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Expected Return
The expected return (or expected gain) on a financial investment is the expected value of its return (of the profit on the investment). It is a measure of the center of the distribution of the random variable that is the return.[1] It is calculated by using the following formula: E [ R ] = ∑ i = 1 n R i P i displaystyle E[R]=sum _ i=1 ^ n R_ i P_ i where R i displaystyle R_ i is the return in scenario i displaystyle i ; P i displaystyle P_ i is the probability for the return R i displaystyle R_ i in scenario i displaystyle i ; and n displaystyle n is the number of scenarios.Although this is what one expects the return to be, it only refers to the long-term average
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Risk
Risk
Risk
is the potential of gaining or losing something of value. Values (such as physical health, social status, emotional well-being, or financial wealth) can be gained or lost when taking risk resulting from a given action or inaction, foreseen or unforeseen (planned or not planned). Risk
Risk
can also be defined as the intentional interaction with uncertainty.[1] Uncertainty
Uncertainty
is a potential, unpredictable, and uncontrollable outcome; risk is a consequence of action taken in spite of uncertainty.[2] Risk perception is the subjective judgment people make about the severity and probability of a risk, and may vary person to person
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Interest Rate Risk
Interest rate
Interest rate
risk is the risk that arises for bond owners from fluctuating interest rates. How much interest rate risk a bond has depends on how sensitive its price is to interest rate changes in the market. The sensitivity depends on two things, the bond's time to maturity, and the coupon rate of the bond.[1] Calculation[edit] Interest rate
Interest rate
risk analysis is almost always based on simulating movements in one or more yield curves using the Heath-Jarrow-Morton framework to ensure that the yield curve movements are both consistent with current market yield curves and such that no riskless arbitrage is possible. The Heath-Jarrow-Morton framework was developed in the early 1991 by David Heath of Cornell University, Andrew Morton of Lehman Brothers, and Robert A
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Consumer Credit Risk
The following article is based on UK market, other countries may differ.Categories ofFinancial riskCredit riskConcentration riskMarket riskInterest rate risk Currency risk Equity risk Commodity riskLiquidity riskRefinancing riskOperational riskCountry risk Legal risk Model risk Political risk Valuation riskReputational riskVolatility riskSettlement riskProfit riskSystemic riskv t e Consumer credit risk
Consumer credit risk
(also retail credit risk) is the risk of loss due to a customer's non re-payment (default) on a consumer credit product, such as a mortgage, unsecured personal loan, credit card, overdraft etc
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Hazard
A hazard is an agent which has the potential to cause harm to a vulnerable target. The terms "hazard" and "risk" are often used interchangeably. However, in terms of risk assessment, these are two very distinct terms. A hazard is any agent that can cause harm or damage to humans, property, or the environment. Risk
Risk
is defined as the probability that exposure to a hazard will lead to a negative consequence, or more simply, a hazard poses no risk if there is no exposure to that hazard. Hazards can be dormant or potential, with only a theoretical probability of harm. An event that is caused by interaction with a hazard is called an incident. The likely severity of the undesirable consequences of an incident associated with a hazard, combined with the probability of this occurring, constitute the associated risk. If there is no possibility of a hazard contributing towards an incident, there is no risk. Hazards can be classified as different types in several ways
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Spot Price
In finance, a spot contract, spot transaction, or simply spot, is a contract of buying or selling a commodity, security or currency for immediate settlement (payment and delivery) on the spot date, which is normally two business days after the trade date. The settlement price (or rate) is called spot price (or spot rate). A spot contract is in contrast with a forward contract or futures contract where contract terms are agreed now but delivery and payment will occur at a future date.Contents1 Spot prices and future price expectations 2 Spot date 3 Examples3.1 Bond 3.2 Currency 3.3 Commodity4 See alsoSpot prices and future price expectations[edit] Depending on the item being traded, spot prices can indicate market expectations of future price movements in different ways. For a security or non-perishable commodity (e.g. silver), the spot price reflects market expectations of future price movements
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Non-deliverable Forward
In finance, a non-deliverable forward (NDF) is an outright forward or futures contract in which counterparties settle the difference between the contracted NDF price or rate and the prevailing spot price or rate on an agreed notional amount. It is used in various markets such as foreign exchange and commodities. NDFs are prevalent in some countries where forward FX trading has been banned by the government (usually as a means to prevent exchange rate volatility).Contents1 Market1.1 List of currencies with NDF market2 Structure and features 3 Pricing and valuation 4 Uses4.1 Synthetic foreign currency loans 4.2 Arbitrage opportunity 4.3 Speculation5 References 6 Other sourcesMarket[edit] The NDF market is an over-the-counter market. NDFs began to trade actively in the 1990s. NDF markets developed for emerging markets with capital controls, where the currencies could not be delivered offshore
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Financial Risk Management
Financial risk
Financial risk
management is the practice of economic value in a firm by using financial instruments to manage exposure to risk: operational risk, credit risk and market risk, foreign exchange risk, shape risk, volatility risk, liquidity risk, inflation risk, business risk, legal risk, reputational risk, sector risk etc. Similar to general risk management, financial risk management requires identifying its sources, measuring it, and plans to address them.[1] Financial risk
Financial risk
management can be qualitative and quantitative
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Risk-adjusted Return On Capital
Risk-adjusted return on capital (RAROC) is a risk-based profitability measurement framework for analysing risk-adjusted financial performance and providing a consistent view of profitability across businesses
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Valuation Risk
Valuation risk
Valuation risk
is the financial risk that an asset is overvalued and is worth less than expected when it matures or is sold. Factors contributing to valuation risk can include incomplete data, market instability, financial modeling uncertainties and poor data analysis by the people responsible for determining the value of the asset. This risk can be a concern for investors, lenders, financial regulators and other people involved in the financial markets. Overvalued assets can create losses for their owners and lead to reputational risks; potentially impacting credit ratings, funding costs and the management structures of financial institutions.[1] Valuation risks concern each stage of the transaction processing and investment management chain
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Profit Risk
Profit risk
Profit risk
is a risk management tool that focuses on understanding concentrations within the income statement and assessing the risk associated with those concentrations from a net income perspective.[1]Contents1 Alternate definitions 2 Description 3 Basis 4 Measurement 5 See also 6 References 7 External linksAlternate definitions[edit] Profit risk
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Settlement Risk
Settlement risk
Settlement risk
is the risk that a counterparty (or intermediary agent) fails to deliver a security or its value in cash as per agreement when the security was traded after the other counterparty or counterparties have already delivered security or cash value as per the trade agreement. The term covers factors incidental to the settlement process which may suspend or prevent a trade from completing, even though the parties themselves are in agreement, are acting in good faith, and otherwise competent to perform. The term applies only to risks inherent to the settlement method of a particular transaction. Broader risks of trading such as political risk or systemic risk may interrupt markets and prevent settlement, but these are not settlement risk per se. One form of settlement risk is foreign exchange settlement risk or cross-currency settlement risk, sometimes called Herstatt risk after the German bank that made a famous example of the risk
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Systemic Risk
In finance, systemic risk is the risk of collapse of an entire financial system or entire market, as opposed to risk associated with any one individual entity, group or component of a system, that can be contained therein without harming the entire system.[1][2] It can be defined as "financial system instability, potentially catastrophic, caused or exacerbated by idiosyncratic events or conditions in financial intermediaries".[3] It refers to the risks imposed by interlinkages and interdependencies in a system or market, where the failure of a single entity or cluster of entities can cause a cascading failure, which could potentially bankrupt or bring down the entire system or market.[4] It is also sometimes erroneously referred to as "systematic risk".Contents1 Explanation 2 Measurement2.1 TBTF/TICTF2.1.1 TBTF 2.1.2 TICTF 2.1.3 Criticisms of systemic risk measurements2.2 SRISK2.2.1 Pair/Vine Copulas3 Valuation of assets and derivatives
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