Risk Management

V/S
Risk Measurement
Risk Measurement
Risk Measurement is necessary to support the management of risk.
Risk Measurement is the specialized task of quantifying and
communicating risk.

Risk Measurement has three goals:

1. Uncovering “Known” risked faced by the portfolio or the firm.

2. Making the known risks easy to see, understand, and compare.
3. Trying to understand & uncover the “Unknown” or unanticipated risks.
Risk Management & Risk Measurement

Risk Management Risk Measurement

1. Tactical & Strategic Decisions 1. Quantifying the Risk

2. Collective Responsibility 2. Specialized Expertise People

3. Purpose to reduce overall 3. Purpose to support

Financial threat Management of Risk
Managing Risk
A]. Market Risk

B]. Foreign Exchange Risk

i. Exposure Netting

ii. Leading & Lagging

iii. Hedging through Derivatives

iv. Marketing Strategies

v. Production Strategies

vi. Financial Management

C]. Liquidity Risk

i. Storing Liquidity

ii. Liquidity Insurance

iii. Limiting exposure to illiquid securities

iv. Investing in open ended funds

v. Trading in exchange traded products

D]. Operational & Legal Risk

Diversification
Advantages of Diversification
1. Reduction of Risk
2. Enhancement of returns

Limitations of Diversifications
3. Systematic risk remains unchanged
4. Increases Complexity
5. Increases the cost of managing the portfolio
Factors to be considered while diversifying

1. Cost

2. Returns

3. Complexity

4. Investment Objectives
Investment Strategies

1. Increasing number of sectors & stocks

2. Use of fixed income securities

3. Inclusion of derivatives in portfolio

4. Alternative investment strategies

5. Globalization of Portfolio
Quantitative Risk Measurement

 Tool 1: Sensitivity Analysis

 Tool 2: Expected Monetary Value Analysis

 Tool 3: Decision Tree Analysis

 Tool 4: Tornado Diagrams

 Tool 5: Modeling & Simulation

 Tool 6: Expert Judgment

Limitations of Quantitative Risk Measurement

1. May not include all risk

2. Backward Looking

3. Complex nature

4. Fails to represent extreme events