Investment risk management
Introduction
There is risk involved in any financial investment; therefore, it is of great essence to manage the risks by minimizing them or removing them completely. Therefore, this paper is going to look at how to manage the risks associated with investments. The financial risk goes hand in hand with the returns such that the higher the returns, the greater the risk. Therefore, it is of great importance to put both risks and returns into consideration before opting to go for an investment. There is an intended and concealed risk that the managers should look at as they affect returns.
Well run investment process is measured by risk management being carried on the investment. Investment risk management is done mainly to assure clients that are managed based on the stated investment strategy. There are different risk controls and requirements depending on the dealing of the company.
Actual returns often differ from the expected returns as the conditions under which expected returns are projected may differ. The returns are used in making decisions for investment but cannot be used for the long-term investments.
Discussion
The existence of financial crisis necessitates companies to incorporate risk management in their investments. When existing risk management fail, investment risk framework helps in such an occurrence. For effective risk management framework, risk objectives and expectations risk quantification, risk managing process and oversight of the process must be put into consideration.
Investment objective and risk management
Investors can be exposed to similar risks but each investor has their own way of viewing the risks. For instance, if a company uses their client’s money, will take risk differently as compared to the one using their own money.
Risk quantification
The exposure impacts on expected risk and performance needs to be quantified and validated against investment convictions and expectations.
Systematic and impartial process
Complexity and size of business warrant embedding processes for risk management into the business’ infrastructure hence removing dependence on individuals.
Oversight and accountability
A good risk management provides the sights of the risks undertaken in order to inform the management and show active tracking and management of the risks. Independent risk team should conduct reviews for accountability purposes.
There are various risks that a business can be exposed into. The risks are:
Market risk
Is the risk related with the great movement in the level of the market prices. The movements are in currency, stocks and interest rates.
Credit risk
Is the risk of loss emanating from movement in credit quality of securities. Credit risk can be caused by widening in spread, downgrade of ratings and default by debtor or counterpart.
Liquidity risk
Occurs due to great price decrease in a security transaction as a result of the market not being deep enough to the extent of accommodating the targeted transaction size.
Operational risk
Is a risk due to operational breakdown of risk management system. operational risk includes power failures, computer issues such as viruses and software bugs and staff personnel failures. Effective operational risk control is the existence of a higher personnel to be reported in the case of staff personnel failure.
Model risk
Occurs when a firm uses inappropriate model or a model with errors or use of incorrect inputs. The best solution to this risk is knowledge.
Legal risk
Emanates from the legal system failing to enforce a contract. In this case the counterparty can go without paying if the market moves against it. To manage legal risk there has to be documentation of all transactions.
Tax risk
Tax risk is a risk that taxes or interpretation of taxes could change abruptly. There is a possibility of completed transactions being re-taxed.
Regulatory risk
Is a risk of change of regulations or regulatory philosophy. Political parties in control choose regulators hence the change of regulations either from light regulation approach to a direct and sober approach.
Settlement risk
Occurs in international transactions. A bank in a certain country may send money to a certain corporation in a different country. The bank being ahead on time will complete the transactions of sending money to the corporation. The corporation the same in its country will be declared bankrupt hence occurrence of settlement risk.
Risks management
- Controlling the risks. Done by allocating risk budgets and setting risk tolerances.
- Done by generating reports systematically and regularly by independent risk team.
- Consistence and comprehensive oversight establishment on entire process, allocating roles and responsibilities with regular review and feedback.
Conclusion
According to this paper it is important to conduct risk management in order to save an established business. There is no business that is not exposed to risks therefore, risk management by control or monitoring or assuring is of essence to save a business from great losses.