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In the realm of financial transactions, risk management refers to the process of identification, analysis, and acceptance or mitigation of uncertainty in investment decisions. In essence, Finance Brokerage Brokers Review risk management takes place when an investor or fund manager analyzes and tries to quantify the potential for losses in an investment and then takes the appropriate action with his investment goals and risk tolerance in mind.
Explaining Risk Management
Risk management takes place everywhere in the financial world. This happens when an investor purchases low-risk government bonds over riskier corporate bonds, when a fund manager hedges his currency exposure with currency derivatives, and when a bank conducts a credit check on a person before giving a personal line of credit.
Stock brokers use financial instruments such as options and futures, while money managers use strategies like portfolio and investment diversification to mitigate or effectively manage risk.
Lacking or insufficient risk management can lead to severe consequences for companies, persons, as well as for the economy.
For instance, the subprime mortgage meltdown in the year 2007 that helped start the Great Depression rooted from poor risk-management decisions, like lender who extended mortgages to people in poor credit, investment firms who bought, packaged, resold these mortgages, and fund that invested too much in the repackaged and still-risky mortgage-backed securities.
Good Risks, Bad Risks, and Necessary Risks
People usually think of Forex Trading and Currency Trading risk in the negative. On the other hand, in the realm of investment, risk is quite necessary and it is inseparable from performance.
One usual denotation of investment risk is a deviation from the expected (or desired) outcome. We can express such in absolute terms or relative to something else, like a market benchmark. That deviation can be positive or negative.
In general, the investing populace agree that in order to achieve higher returns, in the longer run, you have to accept more short-term risk, in the form of volatility.
How much volatility depends on your risk tolerance, which is an expression of the capacity to assume volatility based on certain financial circumstances and the tendency to do so, taking into account the investor’s psychological comfort with uncertainty and the chances of incurring large short-term losses.
How Investors Measure Risks
Investors use several ways to measure and determine risk amounts. One of the most commonly used absolute risk metric is standard deviation, which is a statistical measure of dispersion around a central tendency.
You look at the average return of an investment and then find its average standard deviation over the same time period. Normal distributions dictate that the expected return of the investment is likely to be one standard deviation from the average of 67 percent of the time and a couple of standard deviations from the average deviation 95 percent of the time. This aids investors evaluate risk quantitatively, If they reckon that they can tolerate the amount of risk they find, they will invest.
When applying the bell curve model, any given outcome should fall within one standard deviation of the mean about 67 percent of the time and within two standard deviations about 95 percent of the time.
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