A person interested in a career or degree in economics, business, finance, or a related profession may want to know, “What is risk management?” This is an important concept to understand because it can affect the processes and decisions that a person or a board of directors make. Awareness of managing risks, the methodology, and the purpose of it helps a person avoid unnecessary exposure to financial risks at a personal or business level.
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Identification of Risks
Before a risk can be managed, an individual or business has to identify the situation or problem as a risk for their interests. This initial step of managing risks can be done in a few ways. One way to identify risks is to conduct a source analysis. Risks can be internal or external. For example, a disgruntled employee is an internal risk. A reputation problem or bankruptcy of a client is an external risk. A problem analysis is another way to identify risks. This includes issues such as human errors when entering information into a database.
Determining a Level of Tolerance for Risks
Every individual or business has to determine their level of risk in order to devise ways to manage risks once they reach that tolerance level. Most people or organizations will have different risk tolerances for different products or situations. For example, a person who has most of their retirement fund in the stock market may have one risk tolerance for how much a stock will drop before they choose to sell, and their risk tolerance might be much different for the property value of the rental property they own. Some ways to determine risk tolerance levels include objective measures, scenarios of the risk, and the source of the risk.
How Risks Are Measured
A risk assessment is the first step of measuring risks. The assessment process involves listing all of the types of risks and how serious they are. The second part involves determining how likely each risk is. For example, a category 5 hurricane is a severe risk to oceanfront properties. On the other hand, category 5 hurricanes are rare. In modern financial markets, most risks are measured with computer software and algorithms. Data is continuously fed into these systems, and the software is set up to make predictions about future activity based on past events.
Methods of Managing Risks
Risk is not always a bad thing, especially in finance, explains Investopedia. Risk in financial markets is much like the “no pain, no gain” of exercise and physical training. It is a part of the process and a known entity. Most businesses have several methods for risk management, such as reducing exposure. This is an active strategy for managing risks. A passive strategy for managing financial risks is putting security controls in place. It is important to know that without any risk, an investment cannot achieve any return. Risk and return on investment are essentially intertwined in financial markets.
Many industries include the management of risks in their business plans. Knowing the methodology of how to identify, categorize, manage and ameliorate risks is a critical part of engaging in any type of business activity. Familiarity with the answer to, “What is risk management?” could make it easier for a person to achieve their personal or professional goals.
