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The origin of term of the word RISK can be traced to the latin word RESCUM meaning of danger at sea or that which cuts. A modern business is confronted with many risks, some of which are basic e.g.; loss of property due to natural calamities, civil unrest etc. And some strategic exposure to change in foreign exchanges rates or interest or commodity prices impacting the expected value or the real cash flows of the firm.
Introduction
The purpose of risk management is not necessarily to avoid risk altogether; complete elimination of risk is not possible. Instead the purpose of risk management is to identify which risk are relevant and in what amount. That helps us devising suitable strategies to handle relevant risks.
Meaning of risk
The possibility of suffering harm or loss; danger. The possibility of incurring misfortune or loss; hazard
Though it may be difficult to outline specific targets for risk management, some broad objective included: Mere survival, Peace of mind, Lower risk management costs and thus higher profits, Fairly stable earnings, Little or no interruption of operations, Continued growth, Satisfaction of the firms sense of social responsibility desire for a good image etc.
Types Risk
Types Risk
types of risk the has been identified. It is important to remember, however, that all types of risks exhibit the same positive risk-return relationship. Some of the most important types of risk are defined below. o Default risk o Interest rate risk 1. Price risk 2. Reinvestment risk o Liquidity risk
Types Risk
Default risk
obligations when they come due. Put simply, the risk of non-payment. The event in which companies or individuals will be unable to make the required payments on their debt obligations. Lenders and investors are exposed to default risk in virtually all forms of credit extensions. To mitigate the impact of default risk, lenders often charge rates of return that correspond the debtor's level of default risk. The higher the risk, the higher the required return, and vice versa.
market interest rates. There are two types of interest rate risk identified; price risk and reinvestment rate risk. The price risk is sometimes referred to as maturity risk since the greater the maturity of an investment, the greater the change in price for a given change in interest rates. Both types of interest rate risks are important in banking and are addressed extensively in Bank Management classes.
Present value
Present value
Since interest rates directly affect discount rates and present values of future cash flows represent underlying economic value, we have the following relationships.
Liquidity Risk
The uncertainty associated with the ability to sell an asset on short notice without loss of value. A highly liquid asset can be sold for fair value on short notice. This is because there are many interested buyers and sellers in the market. An illiquid asset is hard to sell because there few interested buyers.
Inflation risk
The loss of purchasing power due to the effects of inflation. When inflation is present, the currency loses it's value due to the rising price level in the economy. The higher the inflation rate, the faster the money loses its value.
Project Risk
In the advanced capital budgeting topics, the total risk associated with an investment project. Sometimes referred to as stand-alone project risk. In advanced capital budgeting, project risk is partitioned into systematic and unsystematic project risk.
Business Risk
The uncertainty associated with a business firm's operating environment and reflected in the variability of earnings before interest and taxes (EBIT). Since this earnings measure has not had financing expenses removed, it reflect the risk associated with business operations rather than methods of debt financing.
Total Risk
While there are many different types of specific risk, we said earlier that in the most general sense, risk is the possibility of experiencing an outcome that is different from what is expected. If we focus on this definition of risk, we can define what is referred to as total risk. In financial terms, this total risk reflects the variability of returns from some type of financial investment.
Broadly defined risk management is concerned with possible reductions in business value from any source. Business value to shareholders, as reflected in the value firms common stock, depends fundamentally on the expected size, timing, and risk ( variability) associated with the firms future net cash flows (cash inflow less cash out flows) . Unexpected changes in expected future net cash flows are a major source of fluctuation in business value. in particular, unexpected reductions in cash inflows or increases in cash outflows can significantly reduce business value
commodity price risk, exchange rate risk interest rate risk. Commodity price risk arises from fluctuation in the prices of commodities, such as coal, copper, oil, gas and electricity, that are inputs for some firm and outputs for others. Due to globalization economic activity, output and input and prices for many firms also are effected by fluctuations in foreign exchange rates.
fluctuate due to changes in Out put and inputs price also can
interest rate. Credit risk: The risk that a firms customers and the parties to which it has lent money will delay or fail to make promised payment is known as credit risk. Pure Risk A risk that is not beneficial to the insurer, as loss is the only foreseeable outcome.