Financial Terms
Economic risk

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Definition of Economic risk

Economic Risk Image 1

Economic risk

In project financing, the risk that the project's output will not be salable at a price that will
cover the project's operating and maintenance costs and its debt service requirements.

Related Terms:

American Depositary Receipts (ADRs)

Certificates issued by a U.S. depositary bank, representing foreign
shares held by the bank, usually by a branch or correspondent in the country of issue. One ADR may
represent a portion of a foreign share, one share or a bundle of shares of a foreign corporation. If the ADR's
are "sponsored," the corporation provides financial information and other assistance to the bank and may
subsidize the administration of the ADRs. "Unsponsored" ADRs do not receive such assistance. ADRs carry
the same currency, political and economic risks as the underlying foreign share; the prices of the two, adjusted for the SDR/ordinary ratio, are kept essentially identical by arbitrage. American depositary shares(ADSs) are
a similar form of certification.

Counterparty risk

The risk that the other party to an agreement will default. In an options contract, the risk
to the option buyer that the option writer will not buy or sell the underlying as agreed.
Country economic risk Developments in a national economy that can affect the outcome of an international
financial transaction.

Asset-specific Risk

The amount of total risk that can be eliminated by diversification by
creating a portfolio. Also known as company-specific risk or
unsystematic risk.

Bankruptcy risk

The risk that a firm will be unable to meet its debt obligations. Also referred to as default or insolvency risk.

Basis risk

The uncertainty about the basis at the time a hedge may be lifted. Hedging substitutes basis risk for
price risk.

Beta risk

risk of a firm measured from the standpoint of an investor who holds a highly diversified portfolio.

Business risk

The risk that the cash flow of an issuer will be impaired because of adverse economic
conditions, making it difficult for the issuer to meet its operating expenses.

Economic Risk Image 2

Call risk

The combination of cash flow uncertainty and reinvestment risk introduced by a call provision.

Classical Macroeconomics

The school of macroeconomic thought prior to the rise of Keynesianism.

Commercial risk

The risk that a foreign debtor will be unable to pay its debts because of business events,
such as bankruptcy.

Company-specific risk

Related: Unsystematic risk

Companyspecific Risk

See asset-specific risk

Completion risk

The risk that a project will not be brought into operation successfully.

Country financial risk

The ability of the national economy to generate enough foreign exchange to meet
payments of interest and principal on its foreign debt.

Country risk General

Level of political and economic uncertainty in a country affecting the value of loans or
investments in that country.

Credit risk

The risk that an issuer of debt securities or a borrower may default on his obligations, or that the
payment may not be made on a negotiable instrument. Related: Default risk

Economic Risk Image 3

Credit Risk

Financial and moral risk that an obligation will not be paid and a loss will result.

Cross-border risk

Refers to the volatility of returns on international investments caused by events associated
with a particular country as opposed to events associated solely with a particular economic or financial agent.

Currency risk

Related: Exchange rate risk

Currency risk sharing

An agreement by the parties to a transaction to share the currency risk associated with
the transaction. The arrangement involves a customized hedge contract embedded in the underlying

Default risk

Also referred to as credit risk (as gauged by commercial rating companies), the risk that an
issuer of a bond may be unable to make timely principal and interest payments.

Diversifiable risk

Related: unsystematic risk.

Economic assumptions

economic environment in which the firm expects to reside over the life of the
financial plan.

economic components model

Abrams’ model for calculating DLOM based on the interaction of discounts from four economic components.
This model consists of four components: the measure of the economic impact of the delay-to-sale, monopsony power to buyers, and incremental transactions costs to both buyers and sellers.

Economic defeasance

See: in-substance defeasance.

Economic dependence

Exists when the costs and/or revenues of one project depend on those of another.

Economic earnings

The real flow of cash that a firm could pay out forever in the absence of any change in
the firm's productive capacity.

Economic exposure

The extent to which the value of the firm will change because of an exchange rate change.

Economic income

Cash flow plus change in present value.

economic integration

the creation of multi-country markets
by developing transnational rules that reduce the fiscal and
physical barriers to trade as well as encourage greater economic
cooperation among countries

Economic life

The period over which a company expects to be able to use an asset.

economic order quantity

Order size that minimizes total inventory costs.

Economic order quantity (EOQ)

The order quantity that minimizes total inventory costs.

economic order quantity (EOQ)

an estimate of the number
of units per order that will be the least costly and provide
the optimal balance between the costs of ordering
and the costs of carrying inventory

economic production run (EPR)

an estimate of the number
of units to produce at one time that minimizes the total
costs of setting up production runs and carrying inventory

Economic rents

Profits in excess of the competitive level.

Economic surplus

For any entity, the difference between the market value of all its assets and the market
value of its liabilities.

Economic union

An agreement between two or more countries that allows the free movement of capital,
labor, all goods and services, and involves the harmonization and unification of social, fiscal, and monetary

Economic Value Added (EVA)

Operating profit, adjusted to remove distortions caused by certain accounting rules, less a charge
to cover the cost of capital invested in the business.

economic value added (EVA)

a measure of the extent to which income exceeds the dollar cost of capital; calculated
as income minus (invested capital times the cost of capital percentage)

economic value added (EVA)

Term used by the consulting firm Stern Stewart for profit remaining after deduction of the cost
of the capital employed.

economically reworked

when the incremental revenue from the sale of reworked defective units is greater than
the incremental cost of the rework


The study of the allocation and distribution of scare resources among competing wants.

Equilibrium market price of risk

The slope of the capital market line (CML). Since the CML represents the
return offered to compensate for a perceived level of risk, each point on the line is a balanced market
condition, or equilibrium. The slope of the line determines the additional return needed to compensate for a
unit change in risk.

Event risk

The risk that the ability of an issuer to make interest and principal payments will change because
of rare, discontinuous, and very large, unanticipated changes in the market environment such as (1) a natural
or industrial accident or some regulatory change or (2) a takeover or corporate restructuring.

Exchange rate risk

Also called currency risk, the risk of an investment's value changing because of currency
exchange rates.

Exchange risk

The variability of a firm's value that results from unexpected exchange rate changes or the
extent to which the present value of a firm is expected to change as a result of a given currency's appreciation
or depreciation.

Fallout risk

A type of mortgage pipeline risk that is generally created when the terms of the loan to be
originated are set at the same time as the sale terms are set. The risk is that either of the two parties, borrower
or investor, fails to close and the loan "falls out" of the pipeline.

Financial risk

The risk that the cash flow of an issuer will not be adequate to meet its financial obligations.
Also referred to as the additional risk that a firm's stockholder bears when the firm utilizes debt and equity.

financial risk

risk to shareholders resulting from the use of debt.

Firm-specific risk

See:diversifiable risk or unsystematic risk.

Flat price risk

Taking a position either long or short that does not involve spreading.

Force majeure risk

The risk that there will be an interruption of operations for a prolonged period after a
project finance project has been completed due to fire, flood, storm, or some other factor beyond the control
of the project's sponsors.

Foreign exchange risk

The risk that a long or short position in a foreign currency might have to be closed out
at a loss due to an adverse movement in the currency rates.

Funding risk

Related: interest rate risk

Geographic risk

risk that arises when an issuer has policies concentrated within certain geographic areas,
such as the risk of damage from a hurricane or an earthquake.

Herstatt risk

The risk of loss in foreign exchange trading that one party will deliver foreign exchange but the counterparty financial institution will fail to deliver its end of the contract. It is also referred to as settlement risk.

High-Risk Small Business

Firm viewed as being particularly subject to risk from an investors perspective.

Idiosyncratic Risk

Unsystematic risk or risk that is uncorrelated to the overall market risk. In other words,
the risk that is firm specific and can be diversified through holding a portfolio of stocks.

Inflation risk

Also called purchasing-power risk, the risk that changes in the real return the investor will
realize after adjusting for inflation will be negative.

Insolvency risk

The risk that a firm will be unable to satisfy its debts. Also known as bankruptcy risk.

Interest rate risk

The risk that a security's value changes due to a change in interest rates. For example, a
bond's price drops as interest rates rise. For a depository institution, also called funding risk, the risk that
spread income will suffer because of a change in interest rates.

Interest Rate Risk

Possibility that interest rates will rise during the term of a loan thereby increasing the annual cost of borrowing.

judgmental method (of risk adjustment)

an informal method of adjusting for risk that allows the decision maker
to use logic and reason to decide whether a project provides
an acceptable rate of return

Leading economic indicators

economic series that tend to rise or fall in advance of the rest of the economy.

Liquidity risk

The risk that arises from the difficulty of selling an asset. It can be thought of as the difference
between the "true value" of the asset and the likely price, less commissions.


The study of the determination of economic aggregates such as total output and the price level.

Market price of risk

A measure of the extra return, or risk premium, that investors demand to bear risk. The
reward-to-risk ratio of the market portfolio.

Market risk

risk that cannot be diversified away. Related: systematic risk

Market Risk

The amount of total risk that cannot be eliminated by portfolio
diversification. The risk inherent in the general economy as a
whole. Also known as systemic risk.

market risk

Economywide (macroeconomic) sources of risk that affect the overall stock market. Also called systematic risk.

Market Risk

The part of security's risk that cannot be eliminated by diversification. It is measured by the beta coefficient.

market risk premium

risk premium of market portfolio. Difference between market return and return on risk-free Treasury bills.


The study of firm and individual decisions insofar as they affect the allocation and distribution of goods and services.

Mortgage-pipeline risk

The risk associated with taking applications from prospective mortgage borrowers
who may opt to decline to accept a quoted mortgage rate within a certain grace period.

Nondiversifiable risk

risk that cannot be eliminated by diversification.

Nonsystematic risk

Nonmarket or firm-specific risk factors that can be eliminated by diversification. Also
called unique risk or diversifiable risk. Systematic risk refers to risk factors common to the entire economy.

Operating risk

The inherent or fundamental risk of a firm, without regard to financial risk. The risk that is
created by operating leverage. Also called business risk.

operating risk (business risk)

risk in firm’s operating income.

Overnight delivery risk

A risk brought about because differences in time zones between settlement centers
require that payment or delivery on one side of a transaction be made without knowing until the next day
whether the funds have been received in an account on the other side. Particularly apparent where delivery
takes place in Europe for payment in dollars in New York.

Political risk

Possibility of the expropriation of assets, changes in tax policy, restrictions on the exchange of
foreign currency, or other changes in the business climate of a country.

Price risk

The risk that the value of a security (or a portfolio) will decline in the future. Or, a type of
mortgage-pipeline risk created in the production segment when loan terms are set for the borrower in advance
of terms being set for secondary market sale. If the general level of rates rises during the production cycle, the
lender may have to sell his originated loans at a discount.

Product risk

A type of mortgage-pipeline risk that occurs when a lender has an unusual loan in production or
inventory but does not have a sale commitment at a prearranged price.

Purchasing-power risk

Related: inflation risk

Rate risk

In banking, the risk that profits may decline or losses occur because a rise in interest rates forces up
the cost of funding fixed-rate loans or other fixed-rate assets.

Regulatory pricing risk

risk that arises when regulators restrict the premium rates that insurance companies
can charge.

Reinvestment risk

The risk that proceeds received in the future will have to be reinvested at a lower potential
interest rate.

Residual risk

Related: unsystematic risk

Reverse price risk

A type of mortgage-pipeline risk that occurs when a lender commits to sell loans to an
investor at rates prevailing at application but sets the note rates when the borrowers close. The lender is thus
exposed to the risk of falling rates.


Typically defined as the standard deviation of the return on total investment. Degree of uncertainty of
return on an asset.


uncertainty; it reflects the possibility of differences between
the expected and actual future returns from an investment


The degree of uncertainty associated with the return on an asset.


A state in which the number of possible future events exceeds the number of events that will actually occur, and some measure of probability can be attached to them.


risk measures the possibility that your investment may lose or gain value as compared to the expected rate of return. risk is different from uncertainty, which is not measurable.


Calculated chance of loss.


return Return earned on an asset normalized for the amount of risk associated with that asset.

risk-adjusted discount rate method

a formal method of adjusting for risk in which the decision maker increases the rate used for discounting the future cash flows to compensate for increased risk

Risk-adjusted profitability

A probability used to determine a "sure" expected value (sometimes called a
certainty equivalent) that would be equivalent to the actual risky expected value.

Risk arbitrage

Speculation on perceived mispriced securities, usually in connection with merger and
acquisition deals. Mike Donatelli, John Demasi, Frank Cohane, and Scott Lewis are all hardcore arbs. They
had a huge BT/MCI position in the summer of 1997, and came out smelling like roses.







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