16/12/2019 Financial Exposure Definition

TRADING SKILLS & ESSENTIALS RISK MANAGEMENT

Financial Exposure Definition

REVIEWED BY CHRISTINA MAJASKI | Updated Jun 25, 2019

What Is Financial Exposure?

Financial exposure is the amount an investor stands to lose in investment should the
investment fail. For example, the financial exposure involved in purchasing a car would be
the initial investment amount minus the insured portion. Knowing and understanding
financial exposure, which is an alternative name for risk, is a crucial part of the investment
process.

https://www.investopedia.com/terms/f/financial-exposure.asp 1/6
16/12/2019 Financial Exposure Definition

KEY TAKEAWAYS
Financial exposure is the amount an investor stands to lose in an investment.
Financial exposure can be an alternative name for risk.
Experienced investors usually seek to optimally limit their financial exposure which
helps maximize profits.
Asset allocation and portfolio diversification are broadly used strategies for
managing financial exposure.

Financial Exposure Explained

As a general rule, investors are always seeking to limit their financial exposure, which helps
maximize profits. For instance, if 100 shares of stock purchased at $10 a share appreciated to
$20, selling 50 shares would eliminate the financial exposure. The original purchase cost the
investor $1,000. As the shares appreciate, selling 50 shares at $20, returns the investors'
initial stake. This method is what is meant by, "taking money off the table."

https://www.investopedia.com/terms/f/financial-exposure.asp 2/6
16/12/2019 Financial Exposure Definition

The only risk going forward would be to the profit made as the investor has already
recouped the principal amount. Conversely, if the stock decreased from the original
purchase price of $10 to $5 per share, the investor would have lost half the original principal
amount.

Financial exposure applies not only to investing in the stock market but exists whenever an
individual stands to lose any of the principal value spent. Purchasing a home is an excellent
example of financial exposure. If the value of real estate declines and the homeowner sells at
a lower price than the original purchase price, the homeowner recognizes a loss on the
investment.

Reducing Financial Exposure

The simplest way to minimize financial exposure is to put money into principal-protected
investments with little to no risk. Certificates of Deposit (CDs) or savings accounts are two
ways to reduce financial exposure drastically. Federal Deposit Insurance Corporation (FDIC)
guarantees both the investment in CDs and the savings account up to the qualified coverage
amounts of US$250,000. However, with no risk, an investment provides little return. Also, if
there is little financial exposure, this leaves a conservative investor vulnerable to other
risks such as inflation.

Another way to reduce financial exposure is to diversify among many investments and asset
classes. To build a less volatile portfolio, an investor should have a combination of stocks,
bonds, real estate, and other various asset classes. Within the equities, there should be
further diversification among market capitalizations and exposure to domestic and
international markets. When an investor diversifies their portfolio successfully among many
asset classes, it should reduce overall volatility. If the market turns bearish, non-correlating
asset classes will minimize the downside.

Real-World Example of Financial Exposure

Hedging is another way to reduce financial exposure. There are many ways to hedge a
portfolio or an investment. The New York Times reported in 2007 that Southwest Airlines had
purchased oil future contracts at lower prices in anticipation as a hedge. Later, when oil
prices were skyrocketing and causing the airline industry to raise ticket prices and shrink

https://www.investopedia.com/terms/f/financial-exposure.asp 3/6
16/12/2019 Financial Exposure Definition

margins, Southwest maintained their lower ticket prices. This availability of lower ticket
prices caused consumers to buy the Southwest tickets, regardless of brand loyalty.

An investor can hedge in the stock market by using options, inverse exchange-traded
funds, or bear-oriented funds. Gold is one of the most common hedges, and it typically
appreciates with an inflating dollar or volatile markets.

Related Terms
Risk
Risk takes on many forms but is broadly categorized as the chance an outcome or investment's actual
return will differ from the expected outcome or return. more

Hey, What's Making That Stock Go Crazy? Could Be Idiosyncratic

Risk
Idiosyncratic risk refers to the risk inherent in an individual asset or asset group, due to the unique
characteristics of that asset. Idiosyncratic risk can be mitigated through diversification in an
investment portfolio. more

What Is Preservation of Capital?

Preservation of capital is a conservative investment strategy where the primary goal is to preserve
capital and prevent loss in a portfolio. more

Investment Vehicle
Investment vehicles are securities or financial asset, such as equities or fixed income instruments,
that an individual uses to gain positive returns. more

Mutual Fund Definition

A mutual fund is a type of investment vehicle consisting of a portfolio of stocks, bonds, or other
securities, which is overseen by a professional money manager. more

The Money You Can't See: Financial Assets

A financial asset is a non-physical, liquid asset that represents—and derives its value from—a claim of
ownership of an entity or contractual rights to future payments. Stocks, bonds, cash, and bank
deposits are examples of financial assets. more

https://www.investopedia.com/terms/f/financial-exposure.asp 4/6
16/12/2019 Financial Exposure Definition

Partner Links

Related Articles
REAL ESTATE INVESTING
Key Reasons to Invest in Real Estate

INVESTING
The Importance Of Diversification

RISK MANAGEMENT
Examples Of Asset/Liability Management

SOFT COMMODITIES TRADING

Timber Investments Cut Down Portfolio Risk

RISK MANAGEMENT
How does market risk differ from specific risk?

https://www.investopedia.com/terms/f/financial-exposure.asp 5/6
16/12/2019 Financial Exposure Definition

FIXED INCOME TRADING STRATEGY & EDUCATION

Why do investors buy fixed-income securities?

TRUSTe

Terms of Use Contact Us News

Advertise Dictionary Careers

Investopedia is part of the Dotdash publishing family.

The Balance | Lifewire | TripSavvy | The Spruce and more

https://www.investopedia.com/terms/f/financial-exposure.asp 6/6