Paper on

Risk Assessment and Risk Management

Written by:

1) Santosh Deoram Watpade MBA (Finance) MET’s Institute of Management Nashik,

2) Siddhi Shrikant Vyas MBA (Finance) MET’s Institute of Management Nashik

Objectives
I. UNDERSTANDING CONCEPT OF RISK.

II.

COVERING DIFFERENT ASPECTS OF RISK ASSESSMENT.

III.

IDENTIFYING KEYS FOR EFFECTIVE RISK MANAGEMENT.

IV.

STUDY THE RISK MANAGEMENT IN PRESENT CRISIS.

I. UNDERSTANDING CONCEPT OF RISK:
Risk means the uncertainty associated with any activity or event or investment. Risk can be known or unknown also can be controllable or non controllable. Risk is the possibility of variance in result than that of expected. Total Risk comprises of systematic and unsystematic risk. Systematic risk means risk occurs due to the factors which are external to the organisation & generally are uncontrollable e.g. Market Risk. Unsystematic risk means risk which occurs due to the internal factors of the organisation & generally is controllable e.g. financial risk. Classification of risk There are three major types of risk. 1. Market risk 2. Operational risk 3. Credit risk

1. Market risk
Today we are passing through a phase where it is not very difficult to define market risk. Anybody will agree that the world is passing through harsh crises and at this point of time any decision right from an investment decision to an expansion decision of an enterprises will impeding risk. Academically this general risk is nothing but ‘market risk’. Market risk is not very new concept; rather it has been stayed with the market itself in one form or other. Market risk is the risk which is common to an entire class of assets and liabilities. Market risk can-not be wished away by diversification it is also called ‘nondiversified risk’ Market risk is the potential for loss due to change in market factors such as interest rates, exchange rates liquidity. Types of market risk A) Currency risk B) Interest rate risk C) Liquidity risk

A) Currency risk Currency risk is potential of loss caused by change in market exchange rate currencies. The corporate has seen a remarkable 69% increase in forex turnover from April 2004 reaching $3.2 TN. India is no exception and has also witnessed tremendous increase in its forex turnover. The massive increase in forex turnover has made both the banks and there customers vulnerable. B) Interest rate risk Interest rate risk is the exposure of the bank’s financial condition to adverse movement in interest risk. Banks typically borrow for short term and led for long term and this process attract reprising risk as interest rate might increase over the period where assets would have been financed at fixed interest rate. C) Liquidity risk Corporate faces liquidity risk due to mismatch in assets and liabilities. Liquidity risk also arises when banks do not loan able funds. In common parlance the risk that arises from the difficulty of selling an asset is called as liquidity risk. When investment banks such as Bear Stearns and Lehman started looking vulnerable, their clients started to withdraw capital and unwind positions leading to run on these investment banks.

2. Operational risk:
An Operational risk is a risk arising from execution of a company’s business functions e.g. legal or fraud risk. Operational risk is a risk of loss resulting from inadequate or failed internal processes, people and systems, etc.

3. Credit Risk
The possibility that bond issuer will default, by failing to repay principal and interest in a timely manner. Bonds issued by the federal government, for the most part, are immune from default (if the government needs money it can just print more). Bonds issued by corporations are more likely to be defaulted on, since companies often go bankrupt. Municipalities occasionally default as well, although it is much less common. It is also called as default risk

II. RISK ASSESSMENT:
If risk is to be controlled, it should be measured carefully. However, measuring risk is extremely difficult task. Tools like standard deviation, correlation regression are available to measure the risk, but these tools are based on certain assumption that may or may not realistic. Risk is the thing which should be taken into account while taking every important decision from starting of the business, carrying of the business till end of the business. All dimension of risk must be identified. Risk that seems smaller should not be ignored, as it can become more prominent as market condition change. Therefore, care & diligence in the identification stage is essential. Every decision should be taken only after analysing subject matter thoroughly & from different angels. Total risk of the organisation should be consolidated. Risk of each functional area should be identified and then should be consolidated. For example, In Finance, there are risks like – Inflation, Exchange rate change, Default in debt, etc. Likewise, risk related to each functional area should be identified, consolidated so that Organisation can take preventive steps in order to control overall risks of the organisation. For assessing the risk properly, time to time monitoring and reporting of risk should take place. If risk cannot be monitored, it cannot be managed. A business unit which cannot monitor the risk that intends to take, it may ultimately sustain losses as result of its inability to accurately recognize and mange its exposures.

III. RISK MANAGEMENT: Keys for effective risk management:
To direct risk behaviour & influence the shape of a firm’s risk profile, management should use all available options. Using financial incentives and penalties to influence risk taking behaviour is effective management tool. Sharing of information by keeping confidentiality intact is also helpful to find out different ways for controlling the risk as valuable inputs may be received through this sharing. Even information on creditworthiness of counterparties that are known to take substantial risk is also can help.

Diversification is extremely important. As it lowers the variance in investor portfolios, improves corporate ability to raise debt, reduces employment risks, & heightens operating efficiency. Governance should never be ignored. Careful structuring of the alliance in advance of the deal and continual adjustment thereafter help to build a constructive relationship. One should not trust while in business. Personal chemistry is good but is no substitute for monitoring mechanism, co-operation incentives, & organisational alignment. Without support system within the organisation itself, external alliances are doomed to fail.

1. Market Risk Management:
We may believe that there are limited tools available to mitigate this risk, but this is not so. Future, option, derivatives trading and its many sub types are some of the tools which help to investors to protect the investment or minimize there exposure toward market risk. In case of derivatives as in broader sense derivative are considered to be used to hedge against market risk, but they can used to mitigate various other types risk also like credit risk, operational risk. A) Currency risk management Effective management of foreign currency risk can help stabilize a company’s performance relative to currency markets. In current crises MNC are managing currency risk with centralized treasury structure which manage regional treasuries and holds responsibilities for all currency exposure and uses mix of netting, compliance and trading and liquidity distribution. . B) Interest Rate Risk Management: This risk can be managed by using derivative instruments or by developing hedging strategies. C) Liquidity crises management Recapitalisation of Banks. Extending Guarantee by central Banks And government

Banning Short Selling Imposing transaction Tax. The importance of managing market risk has now been well understood by financial institutions and corporate across the world. Market risk has made the global financial

conditions uncertain and unsettled and still recovery of problem is not visible in the near time.

2-3) Operational Risk Management & Credit Risk:
These risks can be reduced to great extent by effectively controlling organisation as a whole by taking certain steps like assuring that designed processes carefully & with the help of experts. And are followed in desired way. When it comes to credit risk related to investments that organisation is making, fundamental & technical analysis is a must. Even these investments should be reviewed at required interval.

IV. RISK MANAGEMENT IN PRESENT CRISES
In current situation the credit risk part gets more importance rather than the actual source like market risk. While credit risk is clearly visible the actual problem gets resolved only after attending to the deeper market risk related issues. It is now cleared that current problem arose out of issues related to market risk factors that finally manifested in terms of credit risk factors leading to huge global meltdown. If one can see solutions have been provided, most of them are based on addressing the credit risk problem. These solutions might offer an immediate solution to the current issues, but might not solved long term questions (problem). As there an increased level of importance being given to the credit risk related issues, the case of reduction of importance to market risk may not be a very good strategy and thus reducing the importance to market risk should be clearly reconsidered and appropriate action taken.

Conclusion

Risk must be understood and identified so that they can be managed. Without Quantification of risk it is impossible to determine how much might be gain or loss through any activity. Risk management includes all available tools, techniques, skills and experiences to actively manage the risk.

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