CHAP 8- Risk
and Basic Risk Management Framework
·
'Risks' are uncertainties
resulting in adverse outcome, adverse in relation to planned objective or
expectations.
·
'Financial Risks' are
uncertainties resulting in adverse variation of profitability or outright
losses.
·
Factors that are
responsible for creating uncertainties in cash outflows and cash inflows are
the risk elements.
·
Minimum capital required
for a business should be such that it is able to meet the maximum loss that may
arise from the business to avoid bankruptcy.
·
Lower risk implies lower
variability in net cash flow with lower upside and downside potential. Higher
risk would imply higher upside and downside potential.
·
Zero-Risk would imply no
variation in net cash flow. Return on zero-risk investment would he low as
compared to other opportunities available in the market.
·
Risk in a business or
investment is netted against the return from it and is called Risk Adjusted
Return on investment
·
Key driver in managing a
business is seeking enhancement in risk-adjusted return on capital (RAROC). Higher the RAROC, higher
is the reward to investors/shareholders and more preferable such investment
would be to the market.
·
Although all the risks are
contracted at the transaction level, certain risks such as liquidity risk and
interest rate risk are managed at the aggregate or portfolio level.
·
Risks such as credit risk,
operational risk and market risk arising from individual transactions are taken
cognizance of at transaction- level as well as at the portfolio-level.
·
Volatility over a time
horizon 'T' = Daily Volatility x Square root of'T'
·
Downside potential is the
most comprehensive measure of risk as it integrates sensitivity and volatility
with the adverse effect of uncertainty
·
The value at risk (VaR) is
a downside risk measure.
