Essentials of Risk Management in Finance - Essay Example

RISK MANAGEMENT Techniques available for risk managing a firm’s liability exposure Contents Introduction 3 Discussion 3 Analysis of Risk 7 Conclusion9 References 10 Introduction Risk can be defined as the hazard that restricts the ability of the organization to achieve its goal. The process of managing such type of unexpected risk is referred to as the risk management. Risk management is mainly defined as the process of identification, analyzing, assessing, controlling, avoiding and eliminating the unacceptable risk which will help in investment decision making. The organization mainly uses different risk assessment techniques such as assumption of risk, retention of risk, transfer of risk and acceptance of risk. Risk management can be explained as the process of identification of potential risk and analyzing them and then adopting precautionary measures for curbing and reducing of the risk. Risk management is a two way process which involves determination of risk and then tackling those risk by adopting different measures suitable for the investment objectives of the organization. A well risk management technique decreases the spending and also reduces the negative impact of the risk. While adopting an investment decision the organization faces various financial risks. The intensity of the risk depends on the type of financial instrument used. The financial risk may occur in terms of high volatility in capital market, bankruptcy, recession etc. Risk management is usually found everywhere in this financial world. Risk management is required by an investor when an investor buys more government bonds of low risk as compared to that of the corporate debt that is risky. The organization has to maintain liability to employees and public liability. Discussion Techniques available for managing the risk of a firm’s liability exposure are identifying of risk, assessing the risk, evaluating risk, controlling or monitoring the risk Figure 1: Step of Risk Management Risk Identification: The first step involved in the management of the risk is identification of the risk. It generally includes what type of risk the organization is facing it might be organizational risk, market risk, financial risk, operational risk, inflation risk, disinvestment risk. Risk identification determines and differentiates which risk can affect the organization severely. For identifying the risk the organization is required to understand the peril. The early risk is identified the earlier risk is mitigated. The aid and techniques adopted for identifying the risk are: Review documentation, Gathering different information techniques such as Delphi technique, brainstorming, and analysis of the root cause and interviewing. Analysis of the checklist, assumption of the analysis, technique diagramming which leads to the cause and effect diagram, the process flow chart which influence the diagram, expert judgment and strength weakness opportunity and threat analysis (Li, 2005). Risk Assessment: The second step is assessment of the risk and uncertainties. It mainly deals with assessing the probability of the risk that whether the severity of the risk is high or low. It analyzes the impact of the risk on business. The risk assessment mainly deals with identifying the hazards or the peril, deciding who will be affected by the risk, evaluating the risk and then formulating the precautions; develop the findings and implementing them, at last reviewing the assessment and updating it if required. Controlling and Monitoring (treating the liability risk): The last step is controlling and monitoring the risk. SWOT analysis is to be conducted in order to evaluate the company‘s strength and position to eliminate the risk. Treating the liability risk helps in the determination of risk management tool. This provides an option either to accept the risk or transfer the risk. The demands of the client for providing services vary from time to time. The risk which is related with the changes in business directly influences the liability exposure. Evaluation of Risk: The third step is concerned with the evaluation of risk which deals with the fact that either the risk is to be evaluated by adopting qualitative method or by adopting quantitative method. Liability risk requires the identification of all elements of risk and treating them separately. One best and easier method of evaluating risk is by taking percentage of the occurrence of a particular risk which is to be multiplied by the cost that is estimated (Chorafa, 2011). Different ways of Managing Risk: The different ways of managing risk are as follows. Avoidance of Risk: It is also referred to as the elimination of risk. It refers to the strategy of completely avoiding the activity that leads to the generation of risk. A Merchant may avoid selling a product that will injure the customer. Here the merchant is avoiding product liability. Transfer of Risk: This technique is mainly adopted by the big organization. The risk is passed or is transferred to a third party. It refers to as the sharing of the risk. By sharing the risk the proportion of the risk reduces and a smaller amount of risk is shared by the organization. Liability insurance is a contract in which the insurer agrees to accept the liability in lieu of the payment of a premium of a specified amount. Reduction of Risk: It can be referred to as the mitigation of risk. The two important tool of risk reduction are hedging and diversification of its assets. Retention of Risk: It implies accepting of risk. The retention of risk as a technique of risk management is usually adopted by the small organization because the financial threat of the small organizations is usually less. Figure 2: Risk Management Technique The cost and benefits of risk management procedures can measure in the short run and in the long run by the following ways. The cost benefit of risk measurement procedures can be measured in the long term by conducting a sensitivity analysis which is generally required in case of supporting any conclusions and also in advising or suggesting that the cost allocated are not in proportionate to the benefits provided for implantation of the measure (Fabozzi, 2010). Cost of the risk management measure that can be adopted in the short and the long run are: All of the claimed cost is to be incurred or adopted by the duty holders, the claimed cost are usually shown just to relate to all the measures that are adopted for the implementation of safety of the risk management, the cost should be incurred in such a way that the implementation of the risk reduction technique can be measured, the translation into a monetary cost is usually very uncertain and it should also be justified (Culp, 2002). Benefits of risk management measure that can be adopted in the short and the long run are as follows. Benefits will lead to the reduction of risk, the duty holders are needed to reinstate the cost which is considered as a benefit rather than comparing them against cost. The individuals mainly focus on the short time horizons when the individuals are planning for future and they do not receive or expect any benefit from its investment. Analysis of Risk Risk can be analyzed in two ways either analyzing the risk in qualitative way or analyzing the risk in quantitative way (Christoffersen, 2011). The tools and techniques for analyzing the risk in Qualitative way are as follows. Probability of the risk and assessment of its impact: It signifies the probability that the occurrence of the specific risk will have impact on the quality, cost, and profitability of the organization and then explaining and discussing it with the stakeholders thereafter documenting the desired results. Adopting probability as well as impact matrix: The probability and impact matrix is used for rating the risk that is required analyzing further in qualitative way and it should be formulated in advance by the organization. Categorization of Risk: It refers to categorizing and selecting the areas that are more prone to risk. Grouping this similar type of risk is considered as the efficient and effective response to risk. Assessment of urgency of Risk: The combination of the of the probability and assessment of risk together with the probability as well as impact matrix provides final risk sensitivity rating. Expert judgment: The individual or the organization that have experienced the similar type of risk in the past can provide good analysis and solution to face the risk. The tools and techniques for analyzing the risk in Quantitative way are: Probability Distributions: The probability distribution which is mostly used in simulations and modelling determines the uncertainties of the values the probability distribution is used as a tool in analyzing the risk in quantitative way (Tarantino, 2010). Interviewing: Interview can be conducted for predicting different low and high impact of risk. Sensitivity Analysis: Sensitivity analysis can be adopted as a method for analyzing the risk in a quantitative way. Conclusion Every organization in its course of growth and development are faced with different types of risk and uncertainties. This risk and uncertainties causes loss to the organization which might be low or severe. Identifying and evaluating of risk is very necessary for the organization. Risk management is very important to face the severity of risk. Risk management usually exploits the different types of opportunities that the organization must be familiar with the new options. For undertaking a effective and a efficient risk management technique it is required to have good knowledge and information of the relevant risk, assessing the risk on a continuous basis for monitoring and controlling. Every business gets exposure to the liability loss A business can become legally liable for the injury caused by other person, damage or destruction of the property. The liability results from the court decision, and statutory provisions. References Chorafa, D.N., 2011. Risk management technology in financial services: Risk control, stress testing, models, and its systems and structures. Austria: Butterworth-Heinemann. Christoffersen, P., 2011. Elements of financial risk management. Kidlington: Academic Press. Culp, C.L., 2002., The risk management process: Business strategy and tactics. New York: John Wiley & Sons Fabozzi, F., 2010. Financial risk management. New Jersey: John Wiley and Sons Li. W., 2005. Risk assessment of power systems: Models, methods, and applications, Canada: John Wiley & Sons. Tarantino, A., 2010. Essentials of risk management in finance. New Jersey: John Wiley and Sons. . Read More