Financial risk is the potential losses incurred by an investor when investing in a business that uses borrowed money. When a firm uses a large amount of debt, it incurs a significant interest expense and obligation to repay principal that makes it more likely to have financial difficulties if its cash flows decline. Or, if the entity is a government, it cannot raise sufficient cash from taxes to pay for its bond obligations.
There are several types of financial risk, which include the following:
Liquidity risk. That losses will be incurred when market conditions are highly volatile.
Financial risk can be mitigated through the use of diversified holdings and hedging strategies.