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What is Corporate Risk?

By Josie Myers
Updated May 16, 2024
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Corporate risk refers to the liabilities and dangers that a corporation faces. Risk management is a set of procedures that minimizes risks and costs for businesses. The job of a corporate risk management department is to identify potential sources of trouble, analyze them, and take the necessary steps to prevent losses.

The term "risk management" once only applied to physical threats like theft, fire, employee injuries and car accidents. By the end of the 20th century, the term came to apply also to financial risks like interest rates, exchange rates, and e-Commerce. These financial risks are the most applicable type to corporations.

There are several steps in any risk management process. The department must identify and measure the exposure to loss, select alternatives to that loss, implement a solution, and monitor the results of their solution. The goal of a risk management team is to protect and ultimately enhance the value of a company.

For example, a business has locations in California that are subject to earthquakes, while ones in Florida will most likely encounter hurricanes. The risk management team identifies those physical risks and purchases the appropriate insurance for those situations. Insurance of any kind is truly managing the risk involved with varying scenarios.

With corporations, financial risks are the biggest concern. Just as with standard insurance policies for physical damage, some financial risks can be transferred to other parties. Derivatives are the primary way that corporate risk is transferred.

A derivative is a financial contract that has a value based on, or derived from, something else. These other things can be stocks and commodities, interest and exchange rates or even the weather when applicable. The three main types of derivatives that corporate risk managers use are futures, options, and swaps.

A future is an agreement to purchase an asset at a future date for a particular price. Options give the buyer the option, but not the obligation, to purchase that asset by a given date and price. Swaps are agreements to exchange cash flow before a particular date. All of these place value in the company and some provide backing in case of problems.

In 2008, credit swaps in particular received a great deal of scrutiny after the housing bubble of the previous years burst. During the housing bubble, subprime mortgage lenders were swapping the risk associated with their sub prime loans. The businesses who purchased the risk were then obligated to pay those lenders debts. Those companies holding the risk ended up paying out significantly more money than they ever thought possible. The calculated risk they took did not pay off, while the risk management teams of the original lenders played it safe.

Corporate risk is especially prominent during difficult times in the economy. Risk management teams will take less chances when the economy is less forgiving. They will do everything necessary to avoid additional risks, which in some cases can contribute to a decrease in credit availability and less overall spending.

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Discussion Comments
By SilentBlue — On Feb 22, 2011

@GigaGold

I think you may have inadvertently made the same great fallacy our economy did in the last ten years. While it is true that generally the more investors a given enterprise has, the less the risk will be, it has been proven to not apply everywhere. The reason the world is suffering economically at this time is due to the fact that everybody trusted everybody and we all hopped on the housing market bandwagon. When it collapsed, so did the world economy.

By GigaGold — On Feb 19, 2011

@dbuckley212

There are also corporate bonds, which are different than corporate stock, because they can be bought and sold more fluidly. The corporate bond rates and the risks involved in purchasing these will vary depending on how the business does. Generally, though, the more investment a business has, the less risk it will be likely to have.

By dbuckley212 — On Feb 17, 2011

Stocks can vary in price much like bonds. Bond rates will vary for different nations and businesses depending on how that nation is doing financially. If you notice or intuit that the demand for swiss cheese is likely to spike in the near future, it may be a good step to buy some swiss cheese stocks, since their price will increase in the future and you will have a share in the profit. If a country is going to war and issues war bonds, the economy tends to side with the nation which they think will win, because after the war their bonds rates will spike.

By Armas1313 — On Feb 15, 2011

Risk is an essential aspect of good entrepreneurship. If you want people to invest in you, you need to have a plan that involves taking a step of faith based on a strong idea you've had. The idea must also minimize potential consequences for failures, however, and be a "low-risk risk." The less risk a new venture involves (though it must involve some), the more investment it will tend to get.

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