A financial institution has many duties and one of them is to manage the risk involved when it comes to lending and borrowing money
. There is always some degree of risk and a scenario where there is no risk is not feasible as not even the best forex trading markets can promise a sure thing.
When a financial institution makes a loan or invests in a bond or other debt security, the institution bears credit risk otherwise known as default risk because it is accepting the possibility that the borrower will fail to make either interest or principal payments in the amount and at the time promised. To manage the credit risk of loans or investments in debt securities, financial institutions should diverse a fly their portfolios, conduct a careful credit analysis of the borrower to measure default risk exposure and monitor the borrower over the life of the loan or investment to detect any critical changes in financial health which is just another way of expressing the borrower's ability to repay the loan.
Interest rate risk is the risk of fluctuations in the prices of securities or reinvestment income caused by changes in market interest rates. Forex trading tips the scales in favor of one country or another depending on the inequalities of interest rates set by their respective nations. When central banks talk of interest rates, people listen intently because of how great of an influence interest rates bear on financial decisions. The concept of interest rate risk is applicable not only to bonds but also to the balance sheets of financial institutions. The savings and loan association industry is the prime example of how interest rate risk of adversely affects the earnings of a financial institution. These risks must be managed if an institution wishes to remain in the black.