Professional Documents
Culture Documents
Written by:
1) 2)
Santosh Deoram Watpade Siddhi Shrikant Vyas
MBA (Finance) MBA (Finance)
MET’s Institute of Management Nashik, MET’s Institute of Management Nashik
Objectives
Risk means the uncertainty associated with any activity or event or investment. Risk can be
known or unknown also can be controllable or non controllable.
Total Risk comprises of systematic and unsystematic risk. Systematic risk means risk occurs
due to the factors which are external to the organisation & generally are uncontrollable e.g.
Market Risk. Unsystematic risk means risk which occurs due to the internal factors of the
organisation & generally is controllable e.g. financial risk.
Classification of risk
There are three major types of risk.
1. Market risk
2. Operational risk
3. Credit risk
1. Market risk
Today we are passing through a phase where it is not very difficult to define market risk.
Anybody will agree that the world is passing through harsh crises and at this point of time
any decision right from an investment decision to an expansion decision of an enterprises will
impeding risk. Academically this general risk is nothing but ‘market risk’.
Market risk is not very new concept; rather it has been stayed with the market itself in one
form or other. Market risk is the risk which is common to an entire class of assets and
liabilities. Market risk can-not be wished away by diversification it is also called ‘non-
diversified risk’
Market risk is the potential for loss due to change in market factors such as interest rates,
exchange rates liquidity.
A) Currency risk
B) Interest rate risk
C) Liquidity risk
A) Currency risk
Currency risk is potential of loss caused by change in market exchange rate currencies. The
corporate has seen a remarkable 69% increase in forex turnover from April 2004 reaching
$3.2 TN. India is no exception and has also witnessed tremendous increase in its forex
turnover. The massive increase in forex turnover has made both the banks and there
customers vulnerable.
Interest rate risk is the exposure of the bank’s financial condition to adverse movement in
interest risk. Banks typically borrow for short term and led for long term and this process
attract reprising risk as interest rate might increase over the period where assets would have
been financed at fixed interest rate.
C) Liquidity risk
Corporate faces liquidity risk due to mismatch in assets and liabilities. Liquidity risk also
arises when banks do not loan able funds. In common parlance the risk that arises from the
difficulty of selling an asset is called as liquidity risk. When investment banks such as Bear
Stearns and Lehman started looking vulnerable, their clients started to withdraw capital and
unwind positions leading to run on these investment banks.
2. Operational risk:
An Operational risk is a risk arising from execution of a company’s business functions
e.g. legal or fraud risk. Operational risk is a risk of loss resulting from inadequate or
failed internal processes, people and systems, etc.
3. Credit Risk
The possibility that bond issuer will default, by failing to repay principal and interest in a timely
manner. Bonds issued by the federal government, for the most part, are immune from default (if the
government needs money it can just print more). Bonds issued by corporations are more likely to be
defaulted on, since companies often go bankrupt. Municipalities occasionally default as well, although
it is much less common. It is also called as default risk
II. RISK ASSESSMENT:
Risk is the thing which should be taken into account while taking every important decision
from starting of the business, carrying of the business till end of the business.
All dimension of risk must be identified. Risk that seems smaller should not be ignored, as it
can become more prominent as market condition change. Therefore, care & diligence in the
identification stage is essential. Every decision should be taken only after analysing subject
matter thoroughly & from different angels.
Total risk of the organisation should be consolidated. Risk of each functional area should be
identified and then should be consolidated. For example, In Finance, there are risks like –
Inflation, Exchange rate change, Default in debt, etc. Likewise, risk related to each functional
area should be identified, consolidated so that Organisation can take preventive steps in order
to control overall risks of the organisation.
For assessing the risk properly, time to time monitoring and reporting of risk should take
place. If risk cannot be monitored, it cannot be managed. A business unit which cannot
monitor the risk that intends to take, it may ultimately sustain losses as result of its inability
to accurately recognize and mange its exposures.
We may believe that there are limited tools available to mitigate this risk, but this is not so.
Future, option, derivatives trading and its many sub types are some of the tools which help to
investors to protect the investment or minimize there exposure toward market risk. In case of
derivatives as in broader sense derivative are considered to be used to hedge against market
risk, but they can used to mitigate various other types risk also like credit risk, operational
risk.
Effective management of foreign currency risk can help stabilize a company’s performance
relative to currency markets. In current crises MNC are managing currency risk with
centralized treasury structure which manage regional treasuries and holds responsibilities for
all currency exposure and uses mix of netting, compliance and trading and liquidity
distribution.
Recapitalisation of Banks.
Extending Guarantee by central Banks And government
Banning Short Selling
Imposing transaction Tax.
The importance of managing market risk has now been well understood by financial
institutions and corporate across the world. Market risk has made the global financial
conditions uncertain and unsettled and still recovery of problem is not visible in the near
time.
In current situation the credit risk part gets more importance rather than the actual source like
market risk. While credit risk is clearly visible the actual problem gets resolved only after
attending to the deeper market risk related issues. It is now cleared that current problem arose
out of issues related to market risk factors that finally manifested in terms of credit risk
factors leading to huge global meltdown. If one can see solutions have been provided, most
of them are based on addressing the credit risk problem. These solutions might offer an
immediate solution to the current issues, but might not solved long term questions (problem).
As there an increased level of importance being given to the credit risk related issues, the
case of reduction of importance to market risk may not be a very good strategy and thus
reducing the importance to market risk should be clearly reconsidered and appropriate action
taken.
Conclusion
Risk must be understood and identified so that they can be managed.
Without Quantification of risk it is impossible to determine how much might be gain
or loss through any activity.
Risk management includes all available tools, techniques, skills and experiences to
actively manage the risk.