Risk can be
explained as uncertainty and is usually associated with the unpredictability of
an investment performance. All investments are subject to risk, but some have a
greater degree of risk than others. Risk is often viewed as the potential for
an investment to decrease in value.
Though quantitative analysis plays a
significant role, experience, market knowledge and judgment play a key role in
proper risk management. As complexity of financial products increase, so do the
sophistication of the risk manager’s tools.
We understand risk as a potential
future loss. When we take an insurance cover, what we are hedging is the
uncertainty associated with the future events. Financial risk can be easily
stated as the potential for future cash flows (returns) to deviate from
expected cash flows (returns).
There are various factors that give
raise to this risk. Return is measured as Wealth at T+1- Wealth at T divided by
Wealth at T. Mathematically it can be denoted as (WT+1-WT)/WT.
Every aspect of management impacting profitability and therefore cash flow or
return, is a source of risk. We can say the return is the function of:
¹ Prices,
¹ Productivity,
¹ Market Share,
¹ Technology, and
¹ Competition etc,
Financial risk management Risk management is the process of measuring risk
and then developing and implementing strategies to manage that risk. Financial
risk management focuses on risks that can be managed ("hedged") using
traded financial instruments (typically changes in commodity prices, interest rates,
foreign exchange rates and stock prices). Financial risk management will also
play an important role in cash management. This area is related to corporate
finance in two ways. Firstly, firm exposure to business risk is a direct result
of previous Investment and Financing decisions. Secondly, both disciplines
share the goal of creating, or enhancing, firm value. All large corporations
have risk smanagement teams, and small firms practice informal, if not formal,
risk management.
Derivatives
are the instruments most commonly used in Financial risk management. Because
unique derivative contracts tend to be costly to create and monitor, the most
cost-effective financial risk management methods usually involve derivatives
that trade on well-established financial markets. These standard derivative
instruments include options, futures contracts, forward contracts, and swaps.
The most important element of
managing risk is keeping losses small, which is already part of your trading
plan. Never give in to fear or hope when it comes to keeping losses small.
Risk can be explained as uncertainty
and is usually associated with the unpredictability of an investment
performance. All investments are subject to risk, but some have a greater
degree of risk than others. Risk is often viewed as the potential for an
investment to decrease in value.
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