Risks
All financial contracts bare some risk for at least one side of the contract.
A risk is a potential event that can lead to losses. There are a multiple kinds of risk, here are some:
- Risk of price fluctuations. The contract we entered is not worth anymore the money we invested in it.
- Risk of default of the other counterparty. The counterparty goes bankrupt and cannot pay us anymore.
- Risk of ensured event realizing itself. We have to pay for the risk we ensure.
Risks can be transferred, i.e. sold. This is what happens when we enter into an insurance contract or an option. Some risks are transferred between the counterparties sharing the contractual relationship. This also means that a risk has a price and we have to have ways to compute this price in order to properly transfer risks.
Transferring parts of a risk to someone else is also called hedging the risk.
posted by Walter @ 12:01 AM
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