What is Risk?

  • Market Risk :
  • Equity Risk
  • Interest Risk
  • Currency Risk
  • Concentration Risk: This can manifest into liquidity risk.
  • Credit Risk :
  • Inflation Risk :
  • Longevity Risk :
  • A country that opens operations in a new country gets exposed to currency risk.
  • When you invest in a company, you are taking on equity risk.
  • When you lend money to a friend, relative. You take on credit risk. The risk of not getting the money back.
  • Savings in form of cash lose value due to inflation and thereby cash carries inflation risk and so on.

Risk Management

Now that, we know some broads categories of risk. When trading or running a business. You intend to continue the trade/business while managing/hedging risks.

  • Macro Risk (Overall equity market tanking /going up): The risk here is hedged by appropriate allocation. Think of a combination of equity and bonds.
  • Equity Market Risk: This can be dealt with using the long-short fund. By not being net long or short. We can hedge market movements.
  • Sector Risk: A specific sector due to some policy or other reasons could go up or down. Tax reforms for a sector can make the firms in it soaring. This is eliminated by not being overly exposed to any sector.
  • Idiosyncratic Risk: The risk specific to a company. Some fraud promoter or a new policy. The one way to deal with this is to trade a lot of instruments/stocks. This way, the random events would in a long run cancel each other.
  • Currency Risk: A business like Infosys does business in US dollars and costs money in Rupees. Need to hedge the currency conversion risk.
  • Insurance: There are a lot of transactional risks when doing business such as fire insurance, counterparty risk when buying anything and so on. Insurance firms help with risks such as fire and counterparty risk for business deals can be handled using banks.
  • Planning servers and architecture for 2–10x the traffic depending upon the stage of the product.
  • Having backups and recovery as a part of the system. Risk management in this context is designed to deal with the absolute worst-case situation.

Quantifying Risk

Where ever possible, risk needs to be quantified and accounted for. This is needed to be able to make a decision or call based on the assessment. In trading, the risk of a portfolio is quantified as the volatility of its returns.

Conclusion

While not revenue-generating, an understanding of risk for the domain and it’s management is key to be able to stay in the business and derive the full value out of the operation.

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