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Why is risk management essential in the financial world?

risk management

In the financial world, risk is inseparable from return. Financial risk management occurs when an investor analyses the potential for losses in an investment and takes the appropriate action depending on the investment objectives and risk tolerance.

What is risk management?

risk management

Risk management identifies, assesses, and controls strategic, financial, security, and legal risks of an organization’s capital. These risks can arise from multiple sources like legal liabilities, accidents, economic uncertainties, natural disasters, strategic management errors, technology risk management, etc.

In the financial world, risk is inseparable from return. Financial risk management occurs when an investor analyses the potential for losses in an investment and takes the appropriate action depending on the investment objectives and risk tolerance.

In the financial world, investing is essential while keeping in mind its repercussions and the techniques of risk management. Trading with proper planning results in excellent and profitable returns; for that to happen, financial risk management holds a prominent place in the entire journey.

Five steps of the risk management process

The risk management process involves a series of steps for effective management. This framework includes five basic steps, which are listed below –

  • Risk identification – The initial step is to identify the exact type of risk for the business to take apt measurements. There are many threats, like environmental, regulatory, legal, market, etc.
  • Analyze the risk – After identifying the risk, the risk’s scope must be determined to place the focus points. Risk analysis also helps highlight the common issues that cause such risk situations.
  • Risk assessment – Before taking any action, one needs to prioritize and rank the level of risk depending on its severity. Risk assessment allows exposure to a holistic view of risks to an organization. Risk can be assessed based on two types – qualitative and quantitative.
  • Risk treatment – Once the risk priorities have been set, it’s time to eliminate them with definite strategies and proper execution. This is best done by contacting the experts of that particular risk type. If you are looking for any financial risk experts focusing on investments, trade, the stock market, etc., our SEBI registered research analyst Ashutosh Bhardwaj and his Logical Nivesh team will help you find an effective solution. 
  • Risk monitoring – Keeping a constant check on risks and their solutions is essential to maintain efficiency. Some risks cannot be eliminated, primarily financial and environmental. Therefore, monitoring them with an expert’s advice helps find accurate solutions to reduce their impact.

Financial risk management strategies

Managing financial risk is essential for individuals and companies to operate productively within the economy and the financial system.

Risk avoidance – It involves avoiding the activities that end up in risk formation. For example, eliminating the use of credit for any purchases.

For corporates, activities like expanding operations in areas with high political uncertainty, etc., are a way to eliminate risk.

Risk transfer – It means transferring your risks to a third party. For example, purchasing a life insurance policy to avoid the risk of premature death.

Business risk management can be done by purchasing insurance on their property and transferring the risk of damage to the insurer.

Risk reduction – For individuals, diversifying your investment portfolio reduces the risk of potential losses and saves you from portfolio downfall.

Corporations can hedge foreign currency transactions to reduce exposure to currency fluctuations.

Risk retention involves accepting your responsibility for any particular risk after risk identification. For example, individuals do not insure their property consciously, or corporations deliberately get volatile input costs without insurance.

Financial risk management types

There are four types of financial risks that financial experts have to consider while proposing investment strategies.

  • Operational risk management is the indirect or direct loss caused by inadequate or failed internal processes, systems, or external events. It includes many risk types like environmental, legal, physical, and security. These are not revenue driven and can be managed within acceptable risk tolerance levels.
  • Foreign exchange risk management – When a financial transaction is made in a currency different from the businesses’ operating money due to unfavorable exchange rates between the two.
  • Credit risk management – A credit risk is experienced when borrowers default on their outstanding payments. Other factors, such as increased collection costs, loss of interest, etc., determine the extent of credit risk. Credit risk management solutions involve purchasing insurance, a debt guarantee by a third party, running a credit check, or holding assets as collateral.
  • Reputational risk management – Loss of financial capital from damage to an organization’s reputation is called reputational risk. It can even lead to bankruptcy. However, a proper financial risk management course from expert financial advisors can help eliminate such risks. Our Logical Nivesh team is happy to help you with the same.

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