Finance

Risk Measurement:   In addition to considering profit margins, the risk that an investment can create can be measured quantitatively through statistics.  The most common statistical measure used to describe investment risk is its standard deviation. Standard Deviation: From a statistics standpoint, the standard deviation of a dataset is a measure of the magnitude of deviations between the values of the observations contained in the data set.  From a financial standpoint, the standard deviation can help investors quantify how risky an investment is and determine their minimum required return on the investment. The most common statistical indicator of an asset’s risk is the standard deviation,  σ , which measures the dispersion around the expected value. The expected value of a return, k , is the most likely return on an asset. It is calculated as follows:                   Standard Deviation = n − 1 ∑ i = 1 n ​ ( x i ...

 Risk of a Single Asset: The concept of risk can be developed by first considering a single asset held in isolation. We can look at expected-return behaviors to assess risk, and statistics can be used to measure it.  Risk Assessment: Sensitivity Analysis (Scenario Analysis) and Probability Distributions can be used to assess the general level of risk embodied in a given asset. Sensitivity Analysis: Sensitivity analysis uses several possible-return estimates to obtain a sense of the variability among outcomes. One common method involves making pessimistic (worst), most likely (expected), and optimistic (best) estimates of the returns associated with a given asset. In this case, the asset’s risk can be measured by the range of returns. The range is found by subtracting the pessimistic outcome from the optimistic outcome. The greater the range, the more variability, or risk, the asset is said to have. Although the use of sensitivity analysis and the range is rather crude, it does...

Types of Risk: To understand the basic types of risk, consider what happens to the risk of a portfolio consisting of a single security (asset), to which we add securities randomly selected from, say, the population of all actively traded securities the standard deviation of return, kp, to measure the total portfolio risk, depicts the behavior of the total portfolio risk (y axis) as more securities are added (x axis).  With the addition of securities, the total portfolio risk declines, as a result of the effects of diversification, and tends to approach a lower limit. Research has shown that, on average, most of the risk-reduction benefits of diversification can be gained by forming portfolios containing 15 to 20 randomly selected securities.              The total risk of a security can be viewed as consisting of two parts:                      Total security risk = Nondiversifiable...

Sources of Risk:   Inflation Risk: The purchasing power risk is the factor that affects all the securities. It also refers as the likelihood that the purchasing power of the invested dollars will fall. Even if the nominal return is safe, the real return involves risk with uncertain inflation. The risk is associated with the interest rate risk because the increase in inflation results in the increase in the interest rates. The reason behind this fact is that additional inflation premiums are demanded by the lenders in order to compensate for the loss of purchasing power. Business Risk: Business risk is the risk of conducting business in certain industry or environment. For example the traditional telephone powerhouse  AT&T  confronts many challenges in quickly changing telecommunication industry. Financial Risk: The utilization of debt financing by companies includes the  financial risk . When more assets of the company are financed through debt then the variabili...

  What Is Risk? Risk is defined in financial terms as the chance that an outcome or investment's actual gains will differ from an expected outcome or return. Risk includes the possibility of losing some or all of an original investment. Summary : Risk takes on many forms but is broadly categorized as the chance an outcome or investment's actual gain will differ from the expected outcome or return. Risk includes the possibility of losing some or all of an investment. There are several types of risk and several ways to quantify risk for analytical assessments. Risk can be reduced using diversification and hedging strategies. For example: A $1000 government bond that guarantees it's holder $5 interest after 30 days has no risk because there is no variability associated with the return. A $1,000 investment in a firm's common stock is very risky because the value of that stock may move up or down substantially over the same 30 days. Sources of Risk in Business:   There ar...