risk MANAGEMENT CHAPTER 2

2. Risk Management Vs Risk Measurement
Managing Risk:
• Evaluation:
– Risk measurement means evaluation of he likelihood &
magnitude of a risk
• Core:
– Managing risk is at core of any financial organization
• Decisions to control:
– Managing risk is about making the tactical & strategic decisions
to control those risk (exploit opportunities wherever possible)

3. • Art as well as science:
– Risk management is the art of managing people, processes &
institutions and the science of measuring & quantifying risk
• Tighter connection: It argues for a tighter connection
between risk mgmt & portfolio mgmt
– Risk management: (traditionally focused on monitoring risk)
– Portfolio management: (how much risk to take in pursuit for profit)
• Necessary: Risk measurement is necessary to support
risk management
Risk Management Vs Risk Measurement
Managing Risk:

4. • Specialized task:
– Risk measurement is a specialized task of quantifying &
communicating risk
• Financial Industry
– Risk measurement has grown into a specialized
quantitative discipline
• Other Institutions
– Independent departments with proper reporting lines to
focus on risk measurement
Risk Management Vs Risk Measurement
Managing Risk:

5. Risk Measurement – 3 goals
• Uncovering Known Risk
• Making the Known Risk Easy
• Understanding &uncovering Unknown Risk

6. Diversification
• Diversification is a strategy that mixes a wide variety of investments
within a portfolio in an attempt to reduce portfolio risk.
• Diversification is most often done by investing in different asset classes
such as stocks, bonds, real estate etc.
• Diversification can also be achieved by buying investments in different
countries, industries, sizes of companies, or term lengths for income-
generating investments.
• Diversification is most often measured by analyzing the correlation
coefficient of pairs of assets.
• Investors can diversify on their own by investing in select investments
or can hold diversified funds that diversify on their own.

7. • Diversification strives to smooth out unsystematic risk events
in a portfolio.
• The positive performance of some investments neutralizes
the negative performance of others.
• The benefits of diversification hold only if the securities in the
portfolio are not perfectly correlated—that is, they respond
differently, often in opposing ways, to market influences.
Diversification

8. Diversification: Correlation Coefficient
• Closer to -1:
– There is strong diversification between the two assets, as the
investments move in opposite directions. There is a strong negative
correlation between the two variables being analyzed.
• Closer to 0:
– There is moderate diversification between the two assets, as the
investments have no correlation. The assets sometimes move together,
while other times they don't.
• Closer to 1:
– There is strong lack of diversification between the two assets, as the
investments move in the same direction. There is a strong positive
correlation between the two variables being analyzed.

9. Investment Strategies
• Start now.. How much do you want to invest in the start?
• Choose a Financial Planner
• Start simple.. know your goals.. Take baby steps
• Know the investment vehicles
• Consider Target Date Fund
• Start Auto Saving…Make it a habit
• Track your investment
• Take time to learn.. Play safe…
• If you are in debt?...
• Beat inflation
• Crate emergency Fund First

10. Target Date Fund (for your knowledge only)
• Target-date funds are structured to maximize the investor's
returns by a specific date.
• Generally, the funds are designed to build gains in the early
years by focusing on riskier growth stocks, then they aim to
retain those gains by weighting towards safer, more
conservative choices as the target date approaches.
• The asset allocation of a target-date fund is typically designed
to gradually shift to a more conservative profile so as to
minimize risk when the target date approaches.
• Target-date funds usually mature in 5-year intervals

11. Quantitative Risk Measurement
• It is a formal and systematic method using
measurable, objective data to determine an
asset's value, the probability of loss and other
associated risks.

12. • Calculate numeric values
• Estimate real value of assets
• Estimate potential loss
• Replacement costs
• Confidentiality & Integrity
• Annual estimated loss
• Return on investment (ROI)
• Threats
• Control Measures
Quantitative Risk Measurement

13. Quantitative Risk Measurement - Limitations
• Complex calculations & process
• Difficult to Implement
• No Standards
• Subjective opinions
• Long time
• Hard to Understand

14. End of chapter 2: Risk Management