What is risk management?
Risk management is the systematic process of identifying, evaluating and controlling and monitoring risk or threat of an activity
Risk management can be performed by anyone ranging from an individual to an organization.
The purpose of risk management ,in the context of an organization, is to assess the potential loss and minimize it while enabling the organization to maximize opportunity.
Now that we understand the basic definition of risk management let delve deeper and explore it in the context of Advanced Financial Management (AFM)
Risk and return:
The concept of risk in financial management revolves around the relationship between risk and returns. On that note risk is the potential loss that arises when an expected outcome or gain from investment differs from the actual outcome or gain on investment. The greater the risk an investor takes the greater the potential return.
There are several factors that should be noted:
There is a chance that an investor stands to lose some or all investment considering the risk associated with it
There are different types of risks that are quantified through various methods and techniques for the purpose of analytical assessment
Risk diversification and derivatives can be used to minimize risks
Individuals, financial advisors, and organizations can incorporate these factors in their risk management strategies.
In the context of AFM let’s look at financial risk more closely. When an investor makes an investment there are various risks and returns involved. In general terms, there is a broad category of systematic and unsystematic risks that expose organizations to many kinds of risks.
Systematic risk also known as market risk tends to affect the whole economic market or partly noticeable area of the market. The effect of these risks are macroeconomic in scale. Common examples of systematic risk include interest rate risk, inflation risk, currency risk etc.
Unsystematic risk pertains to risks that partially affect certain industries; these are specific in context of industry or company. These types of risk pose company or industry specific hazard and can be mitigated via diversification which relates to investing in different financial assets to spread the systematic risk associated with it.
Risk and return trade-off
This is an outcome an investor wishes to have where highest returns can be achieved with lowest risk. What actually happens is that low returns are associated with low risk and high risk are likely associated with high return. An investors risk appetite determines the level of risk they are willing to accept for a particular return and therefore it is important to identify what factors contribute to an investors risk appetite
The most effective way to minimize risk involves use of diversification. This technique allows organizations to spread it's unsystematic risk by investing in the security of diverse industries.
It can be concluded that risk management require that a balance is achieved between risk and return in light of an organization's financial goals
This is a basic overview of the main elements of financial risk management. However as an ACCA student and a finalist this topic and many such topics are professionally delivered in AFM course which is taught by VIFHE's qualified tutors.
Plus, there are sufficient technical articles available in ACCA website's resource section relevant to this topic as well.