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Define risk and explain its various types? - Pondicherry University -2015

From the "Risk Management and Insurance" 2015 paper of Pondicherry University.

Asked On2017-10-27 14:35:16 by:Divyanshu-Changkakoti

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Risk management is the process of identifying, assessing and controlling threats to an organization's capital and earnings. These threats, or risks, could stem from a wide variety of sources, including financial uncertainty, legal liabilities, strategic management errors, accidents and natural disasters

Various types:
1. Strategic – One may consider the opening of a competitor in your niche a typical risk. Like the example above you can reduce it’s impact, as you would deal with any other competitor, by offering better service, product and experience. I had a client, unlike the previous example, that was negotiating a lease for a great space on a busy Vancouver street for his coffee shop. All the equipment was purchased, interior designer and staff in place but the leasing agent kept raising the asking price per foot. I took over the negotiations and realized there was an ominous problem – there had to be another bidder for the space. There was competition and it was none other than Starbucks. Needless to say they won over the spot. My client settled for the first space he could find that turned out to be inferior to the detriment of his start-up. He opened and closed within a year.

2. Compliance – You may not see this coming. This is often new regulations or legislation that will change the way you must do business. Vancouver cab owners are bracing for legislation that will allow Uber to move to Vancouver this fall. It could be a game-changer for the industry. Cab owners responded by automating their antiquated call systems.

3. Financial – There’s nothing worse than having completed that huge order and hoping that the client will pay you before the 30 day payment option you gave them. A start-up is not often funded properly to handle multiple accounts that take their time paying or not paying at all. A contingency fund will come in handy.

4. Operational – It sounds silly but my landscaper called the other day to tell me his mower broke down and could he use a weed eater to do my lawn – what? I’m not particularly loyal to this guy so found a company on Google that took care of me within an hour. Using broken equipment like this will take a business down without some backup plan. Imagine what could happen if your partner or key employee dies suddenly, an operational calamity.

5. Environmental – Besides the disaster scenario, there are many environmental issues that could put a hole in your wallet. In a climate change minded world people will shop around for environmentally friendly business owners. You must adapt or go broke.

6. Employee – A former car repair business I once used went out of business after the owner’s accountant absconded to Brazil with most of the money in his business. Ludicrous? Well it’s a true story and one that happens more than you think. A more typical scenario is a critical employee being injured at work without a backup to run his specialty program or machinery.

7. Political – This is a bit different than the compliance issue. Imagine your business is in a border state and NAFTA is being renegotiated. The fate of your entire operation could be tied to whether the agreement is ratified or not. I know many business owners in Canada who are biting fingernails hoping to keep the status quo.

8. Society – The societal landscape is constantly changing and one must adapt and have a plan in place when change knocks at your door. My wife only buys free-range eggs from our grocer. The thought of cramped chickens bred in boxes even has me cringing. Gluten free, organic and non-GMO are buzzwords that are changing the way we do business and shop.

Answerd on:2018-06-05 Answerd By:SaiKiran


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Risk involves the chance an investment's actual return will differ from the expected return.

Let's take a look at the two basic types of risk: 

  • Systematic Risk - Systematic risk influences a large number of assets. A significant political event, for example, could affect several of the assets in your portfolio. It is virtually impossible to protect yourself against this type of risk. 

  • Unsystematic Risk - Unsystematic risk is sometimes referred to as "specific risk". This kind of risk affects a very small number of assets. An example is news that affects a specific stock such as a sudden strike by employees. Diversification is the only way to protect yourself from unsystematic risk. (We will discuss diversification later in this tutorial). 

    Now that we've determined the fundamental types of risk, let's look at more specific types of risk, particularly when we talk about stocks and bonds

  • Credit or Default Risk - Credit risk is the risk that a company or individual will be unable to pay the contractual interest or principal on its debt obligations. This type of risk is of particular concern to investors who hold bonds in their portfolios. Government bonds, especially those issued by the federal government, have the least amount of default risk and the lowest returns, while corporate bonds tend to have the highest amount of default risk but also higher interest rates. Bonds with a lower chance of default are considered to be investment grade, while bonds with higher chances are considered to be junk bonds. Bond rating services, such as Moody's, allows investors to determine which bonds are investment-grade, and which bonds are junk. (To read more, see Junk Bonds: Everything You Need To KnowWhat Is A Corporate Credit Rating and Corporate Bonds: An Introduction To Credit Risk.) 

  • Country Risk - Country risk refers to the risk that a country won't be able to honor its financial commitments. When a country defaults on its obligations, this can harm the performance of all other financial instruments in that country as well as other countries it has relations with. Country risk applies to stocks, bonds, mutual funds, options and futures that are issued within a particular country. This type of risk is most often seen in emerging markets or countries that have a severe deficit. (For related reading, see What Is An Emerging Market Economy?

  • Foreign-Exchange Risk - When investing in foreign countries you must consider the fact that currency exchange rates can change the price of the asset as well. Foreign-exchange risk applies to all financial instruments that are in a currency other than your domestic currency. As an example, if you are a resident of America and invest in some Canadian stock in Canadian dollars, even if the share value appreciates, you may lose money if the Canadian dollar depreciates in relation to the American dollar. 

    Interest Rate Risk - Interest rate risk is the risk that an investment's value will change as a result of a change in interest rates. This risk affects the value of bonds more directly than stocks. (To learn more, read How Interest Rates Affect The Stock Market.) 

  • Political Risk - Political risk represents the financial risk that a country's government will suddenly change its policies. This is a major reason why developing countries lack foreign investment. 

  • Market Risk - This is the most familiar of all risks. Also referred to as volatility, market risk is the the day-to-day fluctuations in a stock's price. Market risk applies mainly to stocks and options. As a whole, stocks tend to perform well during a bull market and poorly during a bear market - volatility is not so much a cause but an effect of certain market forces. Volatility is a measure of risk because it refers to the behavior, or "temperament", of your investment rather than the reason for this behavior. Because market movement is the reason why people can make money from stocks, volatility is essential for returns, and the more unstable the investment the more chance there is that it will experience a dramatic change in either direction.

Answerd on:2017-10-28 Answerd By:Ashwath-Shetty

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