Risk management

Examples of Risk management in the following topics:

• Information and Risk Trade-Off

  • IT risk management can be viewed as a component of a wider enterprise risk management (ERM) system.
  • Some organizations have a comprehensive enterprise risk management methodology in place.
  • IT risk transverses all four of the aforementioned categories and should be managed within the framework of enterprise risk management.
  • Risk appetite and risk sensitivity of the whole enterprise should guide the IT risk management process.
  • ERM should provide the context and business objectives on the management of IT risk.

• Approaches to Assessing Risk

  • Since planned actions are subject to large cost and benefit risks, proper risk assessment and risk management for such actions are crucial to making them successful.
  • In enterprise risk management, a risk is defined as a possible event or circumstance that can have negative influences on the enterprise in question.
  • In a financial institution, enterprise risk management is normally thought of as the combination of credit risk, interest rate risk or asset liability management, market risk, and operational risk.
  • In project management, risk management can include: planning how risk will be managed, assigning a risk officer, maintaining a database of live risks, and preparing risk mitigation plans.
  • Risk can be assessed in a number of ways, and is a critical step in capital budgeting and planning, as well as project management.

• Making Decisions Under Conditions of Risk and Uncertainty

  • Conditions of risk and uncertainty frame most decisions rendered by management.
  • This enables managers to identify likely risks and their potential impact.
  • Once management has identified the appropriate risk category that may impact a certain decision, it may go about quantifying these risks.
  • If managers believe that the firm is suited to absorb potential losses in the event the negative outcome occurs, they will have a larger appetite for risk given their capabilities to manage it.
  • The Deepwater Horizon oil rig fire is an example of a risk faced by a management team.

• Commercial Banks

  • Risk management (i.e. foreign exchange risks, interest rates, hedging commodities, derivatives)
  • Credit Risk – Risk that a borrower may not return the entirety of the payment owed.
  • Liquidity Risk – Risk that an acquired asset cannot be traded quickly enough to capture profit.
  • Market Risk – Virtually any capital asset has a market, and is therefore subjected to the risks of it's respective market.
  • Operational Risk – Risk that an operational issue will diminish returns.

• Risks Involved in Capital Budgeting

  • The process of capital budgeting must take into account the different risks faced by corporations and their managers.
  • When taking on this planning process, managers must take into account the potential risks of the investment not panning out the way they plan for it to, for any number of reasons.
  • Potential losses themselves may also be called "risks. "
  • Each of these risks addresses an area in which some sort of volatility could forcibly alter the plan of firm managers.
  • For example, market risk involves the risk of losses in position due to movement in market positions.

• Measuring and Managing Risk

  • Time is a component of risk for varying reasons; however, the two most common are related to the increase in general uncertainty rising with the time horizon and reinvestment risk.
  • Risk premium compensates holders for risks inherent to an investment and are incorporated in the rate of return quoted for an investment.
  • The differential in yield can be attributed to a risk premium for time to maturity.
  • Another aspect of time horizon is reinvestment risk.
  • To compensate investors for taking on this type of risk, the issuer will provide a risk premium to incentivize the investor to purchase the investment.

• Risk Aversion

  • It attempts to measure the tolerance for risk and uncertainty.
  • People fall under different categories of risk aversion.
  • A risk-averse, or risk avoiding person would take the guaranteed payment of 50, or even less than that (40 or 30) depending on how risk averse they are.
  • A risk neutral person would be indifferent between taking the gamble or the guaranteed money.
  • A firm's management can adopt different stances based on how risk averse they feel they should be, given different market qualities and firm conditions.

• Impact of Diversification on Risk and Return: Unsystematic Risk

  • In general, diversification can reduce risk without negatively impacting expected return.
  • In finance, systematic risk is the term associated with risk that can be diversified away by investing in a broader pool of assets.
  • The risk that can be diversified away is called "unsystematic risk" or "diversifiable risk. "
  • Some investors like to call themselves fans of active or passive management.
  • The other guys–active managers–believe that their fundamental analysis yields them a competitive advantage.

• Types of Risk

  • Prepayment risk is the risk that the buyer goes ahead and pays off the mortgage.
  • Credit risk or default risk, is the risk that a borrower will default (or stop making payments).
  • Operational risk is another type of risk that deals with the operations of a particular business.
  • If you are invested in the Boston Red Sox, your operational risk might include the chance that starting pitchers and recent acquisitions won't perform, that your manager will turn the clubhouse into a mess, or that ownership will not be able to execute a long term strategy.
  • Foreign investment risk involves the risk associated with investments in foreign markets.

• The Value of Diversification

  • The risks that are inherent to a specific investment can be compensated for by a market-assessed risk premium, whereby market participants adjust the price of an asset, impacting its overall return, based on the risk characteristics of the asset.
  • In general, most asset managers would advocate holdings that are diversified across sectors and asset classes to further the benefit of growth and reduce the risk of performance volatility that may be attributable to a company, sector, or asset class .
  • In some cases where the return on investment needs to be met, managers may advocate for the use of hedging instruments to transfer risk of return objectives being met to another party in lieu of a consistent return.
  • Diversification can reduce the risk of any single asset, but there will still be systematic risk (or undiversifiable risk).
  • Systematic risk will affect the portfolio, regardless of how diversified it is.