Lecture #0
Risk management process
Risk Analysis Process
Risk analysis is a qualitative problem-solving approach that uses various tools of assessment to
work out and rank risks for the purpose of assessing and resolving them. The process is –
1) Identify existing risks
• Risk identification mainly involves brainstorming
• A business gathers its employees together so that they can review all the various sources of risk.
• Arrange all the identified risks in order of priority.
Risk Analysis Process
2) Assess the risks
• What caused such a risk and how could it influence the business?
• Prior to figuring out how best to handle risks, a business should locate the cause of the risks
3) Develop an appropriate response
• What measures can be taken to prevent the identified risk from recurring
• What is the best thing to do if it does recur
Risk Analysis Process
4) Develop preventive mechanisms for identified risks
• Effective ideas are developed into a number of tasks and then into contingency plans that can be deployed in the
future.
• Risk Can be measured in
• Absolute
or
• Relative Term
Risk
• Financial Risk Management is the process by which financial risks are
identified, assessed, measured and manages in order to create economic
value.
• Risk can never be entirely avoided. The goal is to minimize the risk.
Absolute vs. Relative Risk
• Risk can be measures in absolute terms or in relative terms (relative
to some benchmark).
• An investment of Rs.100 in a company's shares and a subsequent fall
of 40% in stock price will lead to an absolute risk / absolute loss of
Rs.40
Absolute Risk
• Absolute risk is measured in terms of shortfall relative to the initial
value of the investment
•
Relative Risk
• Relative risk is measured relative to a benchmark index B. The deviation is
- which is also known as the tracking error.
where (TEV)
• To compare these two approaches take the case of an active equity
portfolio manager who is given the task of beating the benchmark. In the
first year, the active portfolio returns -6% but the benchmark drops by -
10%. So the excess return is positive: e= -6%-(-10%)=4%. In relative terms,
the portfolio has done well even though the absolute performance is
negative. In the 2nd year, the portfolio returns +6%, which is good using
absolute measures, but not so good if the benchmark goes up by =10% .
Here excess return e= 6%-(10%)=-4%.