Assignment

Subject: Risk management and insurance

Subject Code: 18MBAFM401

1) Define RISK

Ans: - “Risk is a condition in which there is a possibility of an adverse deviation from a desired
outcome that is expected or hoped for”. “At its most general level, risk is used to describe any
situation where there is uncertainty about what outcome will occur. Life is obviously risky”

2) what are the objectives of Risk Management

Ans: - 1 Identifies and Evaluates Risk

Risk management identifies and analysis various risk associated with business. It identifies risk
at early stages and takes all necessary steps to avoid their harmful effects. Information from past
is analyzed to recognize all possible future unfortunate events. Risk management properly
evaluates risk originated in business and develops a proper understanding regarding its real
causes. This all help in taking all measures in mitigating the effects of these risks.

2 Reduce and Eliminate Harmful Threats

Harmful risks and threat are part of every business organization. They have negative effect on
productivity and profitability of business. Risk management techniques helps in avoiding and
reducing the effect of these threats to business. Risk manager formulates strategic plans for each
department and monitors their performance from time to time. These perform series of workshop
in organization to develop proper understanding regarding risk causes and how to overcome
them among all employees. Managers guide them in avoiding the identified faults and reduces
these harmful threats.

3 Supports Efficient Use of Resources

Risk management aims at efficient utilization of all resources. Fuller utilization leads to better
productivity and increased profits. Risk management techniques support strategic planning for
better results. It sets plans for functioning of business and ensures that all activities are going on
their planned track. Certain targets are set for each division within organizations and perform
routine check-ups from time to time. If any deviations arise, it takes all possible steps.

4 Better Communication of Risk within Organization

Risk management develops better communication network between directors, managers and
employees. It helps in spreading all information regarding risk easily around the organization
timely. All people are able to interact with each other effectively and discuss about core solution
about these risk. This helps in better understanding of several threats and taking timely action
against them.

5 Reassures Stakeholders

Stakeholders are an important part of every business organization. Business must aim at serving
the interest of its stakeholders for their support. Risk management helps in increasing the
confidence of stakeholders in business and assures them of non-occurrence of any unfortunate
incident. They feel safe by the implementation of risk management techniques that will timely
control and avoid all harmful risk. This leads to better trust among business and its stakeholders.

6 Support Continuity of Organization

Risk management has an efficient role in long term growth and survival of the business. Every
business faces several risk and unfortunate events during its life cycle. These unfortunates, if not
treated timely, will affect the organization capital and profit or even leads to its termination. It
avoids all these risks by monitoring continuously the operations throughout the life of the
project. It reduces anxiety by overcoming all fear of uncertainty and develops a safe working
environment within the organization. This increase the productivity and overall stability of
business organizations.

3) What is Risk identification?

Ans: - The first step in Risk Management process is Risk Identification i.e., the identification of
loss Exposures. There are various methods of identifying Exposures. Loss Exposures can be
identified through analysis of the firm's financial statements, surveys of employees, discussions
with insurance agents, Management consultants. Risk identification requires an overall
understanding of the business and the specific economic, legal and regulatory factors that affects
the business.

4) What is Financial Risk?

Ans: - Financial risk is the possibility of losing money on an investment or business venture.
Some more common and distinct financial risks include credit risk, liquidity risk, and operational
risk.

Financial risk is a type of danger that can result in the loss of capital to interested parties.

5) Explain the variance type of Risk

Ans: - variance type of Risk

1) Financial and Non‐financial risks

2) Static and Dynamic risks

3) Fundamental and Particular Risks or Group and Individual risk.

4) Pure and speculative risks.

5) Internal and external risks.

6) Insurable and Non‐insurable risks.

1) Financial and Non‐Financial Risks: If the risk is concurred with Financial Loss it is termed
as financial risk. Financial risk involves the simultaneous existence of three important verticals
of a risky situation. a) Someone is adversely affected by happening of an event. b) The Assets or
Income is likely to be exposed to a financial loss from the occurrence of an event. c) Partly can
cause the loss. Example: Loss occurred in case of damage of property, theft of property, loss of
business. Financial risk is when output / loss can be measured in monetary term. When the
possibility of financial loss does not exist, the situation can be referred to as non ‐financial risk in
nature for Eg risk in selection of career, Risk in the choice of course of study etc., they may or
may not have any financial implications. These types of risks are difficult to measure.

2) Static and dynamic risk: Static risks are those risks which would occur irrespective of any
changes in the economy, such risk results in destruction of an asset or change in its possession.
They are a consequence of human factors like, dishonesty of workers, natural calamities etc.,
these risks are more or less predictable as they have the tendency to occur at regular interval of
time. Static risks can be insured, Dynamic risks are a course of change in the economic
environment. There are less predictable than static risks, as they do not have a defined pattern of
occurrence. For Eg: price level changes, technology changes, change in consumer's tastes etc.,
may cause financial loss to business enterprise, Dynamic risks are not covered by insurance.

3) Fundamental and Particular Risks or Group and Individual risk. Fundamental/ Group
risks affects the economy or a large section of the population at the macro level. They are the
consequence of risk beyond the control of Individuals who suffer the losses. Thus, it is society
and not an individual who is expected to deal with such risks. They are impersonal in origin and
absent caused by the fault of any particular individual and may be caused by economic, social
cultural political and natural factors. Eg: Earthquake, floods, war, inflation and unemployment.
Particular/ Individual risks are personal in origin they are caused by the fault of particular
individuals. They cause losses only to a few individuals, such risks are expected to be dealt with
by individuals rather than the society for Eg: burning of a house /factory, bank robbery, burglary,
theft are particular risks.

4) Pure and speculative risks. Pure risk refers to a chance of loss without any possibility of
gain to the individual. For Eg, when a fire breaks out, it can any cause loss and no gain same way
where a car is insured against accident, the insurance company is liable to compensate the loss, if
the accident occurs, but if the accident does not occur the insured does not get any benefit or
gain. In case of speculative risks, it implies a situation which involves not only the chances of
loss but also a possibility of gain as well. For Eg, investment in stock market may bring either
gain or loss to the investor, other examples of speculative risks includes change in demand, price
fluctuations, and change in fashion and tastes and so on.

5) Internal and External Risks: Internal risks are caused by the internal events associated with
the working of a business enterprise. However, forces belonging to the external environment,
affecting the particular business enterprise cause external risks. Workers strike, breakdown of
machinery, carelessness or dishonesty of employees, disharmony in worker and Management
relationship are examples of the internal risks adversely affecting the working of an enterprise
and likely cause losses. On the other hand, changes in the market conditions distribution,
production, technology and political environment, natural calamities, social unrest are examples
of the external risks which affecting its profit earning capacity. Internal risks can be controlled
with effective Management, but the external risks cannot be controlled so easily.

6) Insurable and Non‐Insurable risks: Insurable risks are pure risks, which can be predicted
and the changes of their occurrence too can be determined. These risks can be shifted through
various types of Insurance policies covering the risk for Eg: Life Insurance, marine Insurance,
fire insurance, vehicle insurance, personal accident insurance, burglary insurance etc., Non‐
Insurable risks are those risks which cannot be covered or shifted through insurance. The
occurrence of these risks cannot be determined. These risks are speculative in nature and cannot
be insured for Eg: Changes in demand, changes in supply changes in fashion, price fluctuations
etc.

6) What are the Advantage & Disadvantage of Risk Management?

Ans: Advantages of Risk Management

1. It encourages the firm to think about its threats. In particular, risk management encourages it
to analyze risks that might otherwise be overlooked.

2. In clarifying the risks, it encourages the firm to be better prepared. In other words, it helps the
firm to manage itself better.

3. It lets the organization prioritize its investment and reduces internal disputes about how money
should be spent.

4. It reduces duplication of systems. Integration of environmental and health and safety systems
are one instance.

Disadvantages of Risk Management

1. Qualitative risk assessment is subjective and lacks consistency.

2. Unlikely events do occur but if the risk is unlikely enough to occur is maybe better to simply
retain the risk and deal with the result if the loss does in fact occur.
3. Spending too much time assessing and managing unlikely risks can divert resources that could
be used more profitably.

7) Discuss the corporate risk management by edge techniques.

Ans: The process of risk management needs to be aimed not only to meet the requirements of
internal policies and guidelines but also to improve the efficiency as other activities of the firm.
So, the risk management process is dynamic in nature and it gives an opportunity the
management to realign goals, and ensure that the need of the firm and design of the risk
management system fits together. Risk Management involves the following steps in case of
corporation / Enterprises. Define the objectives of risk management: Different risk situations
results in different kind of losses. Then the risk managers who deals with their risks must have
certain objectives like

(1) Identify potential losses

(2) Evaluating the potential loss

(3) Selecting appropriate techniques to control losses

(4) Implementing and reviewing the loss controlling programme.

1) Identification of potential loss: The losses identified may be personal risk, property risk,
liability risk. Risks may be losses of carved income to the family because of pre‐mature death of
family head or insufficient income and financial assets during retirement or loss of carved
income due to unemployment. Property risks: May be direct physical damage to personal
property like fire flood, earthquake or theft of valuable like, money, vehicles, etc., Liability risks:
May be legal liability are in gut of negligent operation, professional activities etc.,

2) Evaluation of potential losses, in frequency and severity of loss: Estimating the frequency and
severity of potential losses is the most appropriate technique which is used to deal with the risk
loss severity refers is the probable size of losses that may occur.

3) Selection of appropriate methods for treating losses Exposures: Third step isto select the most
appropriate technique for handling each potential loss. The major methods are loss control by
avoidance, risk retention, non‐insurance& transfer of risk etc.,

4) Implementation and administration of the risk management programme: The risk management
program must be reviewed periodically to find out deviations. If the deviations are significant it
requires a modification or complete renewal of the whole model to manage the risk.
8) Explain the need for rationally for risk management in organizations.

Ans: As discussed so far, risk management is an integrated process of describing specific areas
of risk developing and comprehensive plan integrating the plan and conducting ongoing
evaluation. It is a process that identifies loss Exposures to be faced by an organization and select
the most appropriate techniques including insurance for meeting such Exposures. So far
Managing the risk there is a need for rational i.e., need for cause of action which included
guidelines and responsibilities.

Guidelines for Risk Management

a) Problems should be kept in perspective

b) Hazards can be controlled they are not a cause for panic

c) Judgments should be based upon knowledge experiment

d) Encourage all participants in an operation to adopt risks management principles, to manage

risk more effectively.

e)It is more productive to show a mission plainer how he can better manage risk.

9) What is Risk Management? Describe the Risk Management Process in details.

Ans: Risk Management is an integrated process of delineating specific areas or risk, developing a
comprehensive plan, integrating the plan and conducting on going evaluation.

Risk Management Process: The risk Management process is a systematic approach by which an
organization can identify and manage its exposures to risk, in ways that best fit its strategic
goals. Corporate and non‐ corporate entities have designed their risk management programs
around the process and it has recently been adopted for use in the enterprise risk management
initiatives of many firms. The risk Management process involves the following logical steps.

(1)Define the objectives of risk management excrete (Goals of Risk management function)

(2)Identify the risk exposures/ potential loss Exposures.

(3) Evaluating the exposures / analyzing Loss exposures

(4) Critical Analysis of risk management alternatives and selecting one of them
(Choose/select/Risk, Handling Many techniques)

(5) Implementation and review (Implement techniques and Monitor effectiveness

(1)Define objectives of risk Management / Goals of Risk Management Function: The first
step in the process is to set the objectives of the risk Management function, so they are consistent
with the strategic goals of the organization. The objectives of a multinational corporation are
often different from goals of a non‐profit charity. Risk Managers across all disciplines generally
share a common goal, i.e., to ensure that the organization will survive if it suffers significant
financial loss. Most risk Managers also strive to minimize the chance that an unexpected event
will disrupt the normal operation of their organizations or impede its growth once these basis
objectives have been satisfied many organizations tailor their risk management goals to fit their
unique characteristics and capabilities.

(2) identify potential Loss Exposures (Identify the risk Exposures): After setting its
objectives, the risk management department must next identify are possible Exposures to loss.
The risk / loss, identification requires knowledge of the organization on the market in which it
operates the legal, social, economic, political and climatic environment in which does its
business, itsfinancialstrengths and weakness, its vulnerability to unplanned losses, the
manufacturing processes, and the management, systems and business mechanism by which it
operates. Any failure at this stage to identify risk may cause a major loss for the organization. It
is difficult to summaries the wide variety of loss Exposures, because the risk Exposures vary
dramatically across firms and industries.

(3) Evaluation of Risk Exposures and Analyzing Loss Exposures: Risk evaluation breaks
down into two parts ‐ the assessment of,

a) The probability of loss occurring and

b) Measuring its severity.

a) After identifying the loss Exposures or the organization the risk management dept. must next
take steps to quantify the financial impact of each aspect. In order to quantify risk “VALUE AT
RISK” is the most popular measure, to forecast the future VAR measures the work expected loss
over a given period under the normal market conditions at a given confidence level. In its most
general form the value at Risk measures the potential loss in value f a risky asset over a defined
period for a given confidence interval.

b) Measuring the severity is difficult task. The risk Management department does neither know
whether the loss will occur nor do they know the size of the loss if it occurs. Two quantitative
measures of the loss Exposures are especially useful. The frequency of the loss Exposures and
the severity of the loss, the frequency of the loss exposure measure the numbers of losses that
might occur over a given period of time. The severity of the loss is a measure of the size f the
loss, if the loss is assumed to occur. The risk management dept. often will rely on the firm’s prior
loss experiences to estimate future loss frequency and severity
(4) Choose/select Risk Management Techniques: (Risk Handling Techniques): The methods
that organizations can choose to deal with their loss Exposures are referred to collectively as risk
handling techniques. A variety of risk handling techniques are available and management often
use more than one to address a specific loss exposure. These techniques often are categorized
into three broad categories, i.e., loss control, loss transfer and loss financing.

a) Risk control / Loss control: Risk control covers all those measures aimed at avoiding
eliminating or reducing the changes of loss‐producing events, occurring or limiting the severity
of the loss that do happen. Here one is seeking to change the conditions that bring about loss‐
producing events or increase their severity. Loss control can be exercised into two ways.

(1) One way is to enhance and monitor the less of precautions taken to minimize the losses due
to exposure

(2) Secondly to control the minimize the risk operations, internal risk control techniques include
diversification and / or investment in getting information of loss Exposures so as to control them.
b)Risk transfer / Loss Transfer: Risk transfer implies that the exposed party transfers whole or
part of losses consequential to risk exposure to another party for a cost. The insurance contracts
fundamentally involve risk transfer. Apart from the insurance, there are certain other techniques
by which the risk may be transferred.

(1) Insurance is a contract of transfer of risk. The insurance co agrees to indemnify the losses
arising out an occurrence pre‐determined and charges for this act called as “PREMIUM”. The
insurance method of risk transfer is most appropriate, when the severity of loss is very high

(2) Non‐insurance transfers: The most common methods are (a) Hold‐harmless agreements or indemnity
agreements are contractual relationships specifying that all losses shall be borne by the designated
party.

Eg: A land lord contracting that all losses shall be borne by the tenant

(b) Incorporation is another method for

Eg: Proprietorship or partnership can convert themselves into public companies, to share the loss or
liability among shareholders.

c) Loss Financing/ Risk Financing: When the risk exposure for an organization egceedsthe maximum limit
that the organization can bear it becomes necessary to either transfer or reduce risk. However, these
are a cost involved in both of these exercises. It has been recognized that in the long run, an
organization will have to pay for its own losses. The primary objective of risk financing is to spread more
evenly over time cost of risk, in order to reduce the financial strain and possible insolvency which
random convince of large losses may cause. The secondary objective is to minimize risk costs. Identically
an organization can finance its risk cost in three ways.

(1) Losses may be charged as they occur to current operating costs or

(2) Providing may be made for losses, either through the purchase of insurance or building up a
contingency find to which losses can be charged.

(3)When losses occur, they may be financed will loans, which are repaid over the next few years. Risk
financing / loss financing includes the following alternatives (a) Risk Retention: Risk retention implies
that the losses arising due to a risk exposure shall be retained or assumed by the organization. Risk
retention is generally a better decision for business organization inherited with the following
characteristics (A) The consequential losses are small and / or (B) the losses shown as operating
expenses can be funded with retained profits.(b) Self‐insurance: Self‐insurance acts as an alternative to
buying insurance in the market or when part of the claim is not insured in the commercial market. It
may be done by keeping aside funds to meet insurable losses.

(5)Implement and Monitor the Risk Management Program: Risk Management department in the
organization involves implementing and risk handling methods selected by the firm. The risk
management environment changes rapidly, large organizations constants, introduces new products or
services, acquires or sells operations, and adjust their capital costs. Markets for insurance and non‐
insurance techniques also are subject to significant fluctuations in prices and supply. Changes in
insurance and risk management and also can require quick adjustments in risk management strategy.
For all these reasons the organization must continually monitor and occasionally adjust their firm’s
methods of handling risk.

10) Explain the individual Risk Management & Cost of Risk.

Ans: Individual Risk Management

Insurance is part of the foundation of a complete financial security plan. It helps protect you and
your family in the event of death, a disability or critical illness. While you're still living, some
life insurance policies can build tax-advantaged cash value which can be drawn upon1 to help
you achieve goals, such as buying a house or retiring comfortably.

To help meet your financial security planning needs, we have access to a broad range of
insurance products. These products are designed to meet the diverse needs of individuals,
families, professionals, executives, business owners and employees, including the needs of part-
time and seasonal workers.

 Life insurance
 Disability insurance
 Critical illness insurance
 Health and dental insurance
 Private Health Services Plan
Cost of risk

The cost of risk has five main components, namely

(1) Expected losses

(2)The cost of loss control

(3) The cost of loss financing

(4) The cost of internal risk reduction and

(5) The cost of any residual uncertainty that remains after loss control.

(1) Expected Cost of Losses: The expected cost of losses includes the expected cost of both
direct and indirect losses. Major types of direct losses include the cost of repairing or replacing
damaged assets, the cost of paying workers compensation claims to injured workers, and the cost
of defending against and settling liability claims. Indirect losses include reduction in net profits
that occur as a consequence of direct loss, such as the losses include reduction in net profits and
continuing due to direct damage to physical assets.

(2) Cost of loss control: The cost loss control reflects the cost of increased precautions and limits
on risky activity designed to reduce the frequency and severity of accidents, for Eg: the cost of
loss control for the pharmaceutical company would include the cost of testing the product for
safety prior to its introduction and any lost profit from limiting distribution of the product in
order to reduce exposure to lawsuits.

(3) Cost of loss financing: The cost of loss financing includes the cost of self ‐insurance the
loading in insurance premiums, and the transaction costs in arranging negotiating, and enforcing
hedging arrangements and other contractual risk transfers. The cost of self‐insurance includes the
cost of maintaining reserve funds to pay losses.

(4) Cost of Internal risk reduction method: The cost of internal risk reduction includes
transaction costs, associated with achieving diversification and the cost associated with
managing diversified setoff activities. It also includes the cost of obtaining re‐analyzing data and
other types of information to obtain more accurate cost forecasts. In some cases, this may
involve paying another firm for this information.

(5) Cost of Residual uncertainty: The cost of uncertainty that reminisce., left over once the firm
has selected and implemented loss control loss financing, and internal risk reduction is called the
cost of residual uncertainty, for Eg: residual uncertainty can affect amount of compensation that
investors require to hold a firm’s stock. Residual uncertainty also can reduce value through its
effects, on expected net cash flow for Eg: residual uncertainty might reduce the price that
customers are willing to pay for the firm’s products.
11) what are Business Risk Exposes?

Ans: Business risk is the exposure a company or organization has to factor(s) that will lower its
profits or lead it to fail. Anything that threatens a company's ability to achieve its financial goals
is considered a business risk. There are many factors that can converge to create business risk.
Sometimes it is a company's top leadership or management that creates situations where a
business may be exposed to a greater degree of risk.

12) Illustrate tools and techniques of risk identification?

Ans: Risk Identification tools and techniques

• Documentation Reviews. ...

• Information Gathering Techniques. ...

• Brainstorming. ...

• Delphi Technique. ...

• Interviewing. ...

• Root Cause Analysis. ...

• Swot Analysis (STRENGTH, Weakness, Opportunities And Threats) ...

• Checklist Analysis.

• Assumption Analysis.

1. Documentation Reviews

The standard practice to identify risks is reviewing project related documents such as lessons
learned, articles, organizational process assets, etc

2. Information Gathering Techniques

The given techniques are similar to the techniques used to collect requirements. Lets look at a
few of them:

3. Brainstorming
Brainstorming is done with a group of people who focus on identification of risk for the project.

4. Delphi Technique

A team of experts is consulted anonymously. A list of required information is sent to experts,

responses are compiled, and results are sent back to them for further review until a consensus is
reached.

5. Interviewing

An interview is conducted with project participants, stakeholders, experts, etc to identify risks.

6. Root Cause Analysis

Root causes are determined for the identified risks. These root causes are further used to identify
additional risks.

7. Swot Analysis (STRENGTH, Weakness, Opportunities And Threats)

Strengths and weaknesses are identified for the project and thus, risks are determined.

8. Checklist Analysis

The checklist of risk categories is used to come up with additional risks for the project.

9. Assumption Analysis

Identification of different assumptions of the project and determining their validity, further helps
in identifying risks for the project.

13) Elaborate the exposures to work related injury?

Ans: A work related injury is an injury or illness caused, contributed or significantly aggravated
by events or exposures in the work environment. Work related injuries occur on the job and as a
direct result of the tasks allotted to the specific job.

Workplace injuries or illnesses are generally physical, but can also be psychological. The
sufferer may claim and get get compensation if he or she can prove that his injury or illness
occurred at work or is due to the workplace environment. The concept of work related injury is
gradually evolving in the world due to human right activists, workers’ associations, and
government laws.

The definition of work related injury or illness, which is the basis of compensation claims, is not
yet universally accepted. However, there are some principles that are generally followed:

Purpose - nature of work related injury

Victim - clearly distinguishing direct workers, indirect victims and others affected by such a
work environment

Type of injury or illness - defining the type of injury and illness

Identifying acute or chronic injury - determining whether the illness is acute or chronic

Burden of proof - must be well defined

Classification systems - classification systems should reflect the above principles for study of
data

14) Discuss the exposures of human assets?

Ans: Human asset exposure: Human resource is an asset, the injury or death of employees will
effect the management of HR and also the internal operation of the firm.

16) Write a short note on: a) Burden of risk b) Degree of risk

Ans: - a) Burden of risk :

Burden of risk refers to the costs, losses and disabilities one has to bear as a result of being
exposed to a given loss situation/event.

There are two types of risk burdens that one carries – primary and secondary.

a) Primary burden of risk: The primary burden of risk consists of losses that are actually
suffered by households (and business units), as a result of pure risk events. These losses 9 are
often direct and measurable and can be easily compensated for by insurance.

Example When a factory gets destroyed by fire, the actual value of goods damaged or destroyed
can be estimated and the compensation can be paid to the one who suffers such loss. If an
individual undergoes a heart surgery, the medical cost of the same is known and compensated.

In addition there may be some indirect losses. Example A fire may interrupt business operations
and lead to loss of profits which also can be estimated and the compensation can be paid to the
one who suffers such a loss.

b) Secondary burden of risk: Suppose no such event occurs and there is no loss. Does it mean
that those who are exposed to the peril carry no burden? The answer is that apart from the
primary burden, one also carries a secondary burden of risk.
The secondary burden of risk consists of costs and strains that one has to bear merely from the
fact that one is exposed to a loss situation. Even if the said event does not occur, these burdens
have still to be borne. Let us understand some of these burdens:

Firstly there is physical and mental strain caused by fear and anxiety. The anxiety may vary from
person to person but it is present and can cause stress and affect a person‟s wellbeing.

Secondly when one is uncertain about whether a loss would occur or not, the prudent thing to do
would be to set aside a reserve fund to meet such an eventuality. There is a cost involved in
keeping such a fund.

For instance, such funds may be held in a liquid form and yield low returns. By transferring the
risk to an insurer, it becomes possible to enjoy peace of mind, invest funds that would otherwise
have been set aside as a reserve, and plan one‟s business more effectively. It is precisely for
these reasons that insurance is needed.

b) Degree of risk:

As specified by the commander, the risk to which friendly forces may be subjected from the
effects of the detonation of a nuclear weapon used in the attack of a close-in enemy target;
acceptable degrees of risk under differing tactical conditions are emergency, moderate, and
negligible.

17) Discuss the various sources of risk?

Traditionally investors have talked about several sources of total risks, such as interest rate risk
and market risk, which are explained below, because these terms are used so widely. Following
this discussion, we will define the modern portfolio sources of risk, which will be used later
when we discuss portfolio and capital market theory.

Interest Rate Risk:

The variability in a security’s return resulting from changes in the level of interest rates is
referred to as interest rate risk. Such changes generally affect securities inversely; that is, other
things being equal, security prices move inversely to interest rates. Interest rate risk affects bonds
more directly than common stocks, but it affects both and is a very important consideration for
most investors.

Market Risk:

The variability in returns resulting from fluctuations in the overall market that is, the aggregate
stock market is referred to as market risk: All securities are exposed to market risk, although it
affects primarily common stocks. Market risk includes a wide range of factors exogenous to
securities themselves, including recessions, wars, structural changes in .the economy, and
changes in consumer preferences.

Inflation Risk:

A factor affecting all securities is purchasing power risk, or the chance that the purchasing power
of invested dollars will decline/With uncertain inflation, the real (inflation-adjusted) return
involves risk even if the nominal return is safe (e.g., a Treasury bond).

Business Risk:

The risk of doing business in a particular industry or environment is called business, For
example, AT&T, the traditional telephone powerhouse, faces major changes today in the rapidly
changing telecommunications industry.

Financial Risk:

Financial risk is associated with the use of debt financing by The larger the proportion of assets
financed by debt (as opposed to equity), the larger the variability in the returns, other things
being equal. Financial risk involves the concept of financial leverage, which is explained in
managerial finance courses.

Liquidity Risk:

Liquidity risk is the risk associated with the particular secondary market in which a security
trades. An investment that can be bought or sold quickly and without significant price concession
is considered to be liquid. The more uncertainty about the time element arid the price concession,
the greater the liquidity A Treasury bill has little or no liquidity risk, whereas a small over-the-
counter (OTC) stock may have substantial liquidity risk.

Exchange Rate Risk:

All investors who invest internationally in today’s increasingly global investment arena face the
prospect of uncertainty in the returns after they-convert the foreign gains back to their own
currency Unlike the past when most S. investors ignored international investing alternatives,
investors today must recognize and understand exchange rate risk, which can be defined as the
variability in returns on securities caused by currency fluctuations. Exchange rate risk is
sometimes called currency risk. For example, a U.S. investor who buys a German stock
denominated in marks must ultimately convert the returns from this stock back to dollars. If the
exchange rate has moved against the investor, losses from these” exchange rate’ movements can
partially or totally negate the original return earned.
Country Risk:

Country risk also referred to as political risk, is an important risk for investors today probably
more important now than in the past. With more investors investing internationally, both directly
and indirectly, the political, and therefore economic, stability and viability of a country’s
economy need to be considered. The United States arguably has the lowest country, risk, and
other countries can be judged on a relative basis, using the United States as a benchmark.
Examples of countries that needed careful monitoring in the 1990s because of country risk
included the former Soviet Union and Yugoslavia, China, Hong Kong, and South Africa. In the
early part of the twenty-first century, several countries in South America, Turkey, Russia, and
Hong Kong, among others, require careful attention.