In the world of finance, risk management is associated with mitigation and analysis of ambiguity related to investment decisions. In simple terms, risk management occurs when a fund manager or investor studies and makes an effort to reduce the potential loss in a particular investment. This is followed by appropriate action keeping the investment objectives and risk tolerance in mind.
Uncertainty forms the core of risk. One might not be sure about the likeliness of an event, and about its consequences. Likelihood stands for the probability of an event, and with the expected impact, it characterizes the magnitude of the risk. All risk management processes are basically similar, as they follow a given set of rules. However, there are five steps common in almost every process.
How investors measure risk?
Identifying the risk: The risk management team uncovers, recognizes, and describes the risks that might impact the project and its outcomes. A number of techniques are involved in this step, and the beginning is done with the preparation of “Project Risk Register” and financial statements.
Analyzing the risk: After the identification of the risks, it is essential to study the probability and the results of each risk. This will help in developing an understanding of the type of risk and its capability to impact the project, its goals, and the objectives. All this information also goes into the “Project Risk Register”.
Ranking or Evaluating the risk: The evaluation of the risk is done by the determination of risk magnitude in financial statements. This is basically the combination of possibility and outcome of the risks involved. Decisions regarding the severity and treatment of the risk are done next.
Treating the risk: Also known as Risk Response Planning, this step is taken to assess the risk which is of top priority and for the formation of the relevant plans to minimize or eliminate them. This is the time for the formation of strategies and contingency plans.
Reviewing and monitoring the risk: In this step, the Project Risk Register is referred for monitoring, tracking and reviewing the risks.
Risk is an essential part of business
People usually associate risk with negativity. However, it must be accepted that risk is an inseparable and necessary part of the investment world. The performance of any organization is dictated by the risks it handles, which impacts its value crucially. In laymen terms, the risk is defined as “a deviation from a calculated outcome.” Investors employ a range of tactics for ascertaining risk. One of the proven risk metrics is “standard deviation”, which is a measure of dispersion around the principal tendency.
Since risk is related to uncertainty, putting a framework around the latter will decrease the risk surrounding the project. For a better understanding of risk management, contact Institute for Financial Analysts. They look after the industry’s needs of professionals for risk management and other services. For more information, visit their website.