BFN 416 for HND ll (First semester).

Course Title…. Enterprise Risk Management l.

Course outline:
1. Understand the fundamentals of risk management.

2. Appreciate operational risk.

3. Understand market risk.

4. Understand investment risk.

Week 1, 2 and 3: Understand the fundamentals of risk management.

At the end of the class, students are expected to understand the following:
**The meaning and concept of risk.
**The key principles in risk management.
**Risk and returns.
**Risk management process.

**Risk governance structure.

**Risk reporting.

What is a risk?

Risk is the possibility of something bad happening or measures the future

uncertainty that an investor is willing to take to realize a gain from an
investment. Risks could also be an individual or organisational exposure to the
possibility of loss, injury, or other adverse or unwelcome circumstance, a chance
or situation involving such a possibility.

Risk is a harm that could occur or the probability of an outcome having a

negative effect on people, systems or assets. Risk is typically depicted as being a
function of the combined effects of hazards, the assets or people exposed to
hazard and the vulnerability of those exposed elements.

Types of risks:

Risks are of different types and originate from different situations. Various risks
originate due to the uncertainty arising out of various factors that influence an
investment or a situation.

Below are some of the common risks:

 Natural Risks
 Health or Medical Risks
 Geopolitical Risks
 Climatic Risks
 Economic Risks
 Legal or Compliance Risks
 Security or Fraud Risks
 Financial Risks
 Reputation Risks
 Operational Risks
 Competitive Risks.
Natural risks

Risks caused by natural phenomena, which may create harm to the populations,
animals, equipment or structures.
They are managed by authorities, individuals, organizations e.t.c
Examples of natural risks include: Storm, flooding, hot weather, earthquake e.t.c

Health or Medical risks.

Health risks historically concern problems of contamination. Health risks affect

mainly human being and animals and it becomes a major health disaster when it
is no longer under control.
Examples of health risks are: Exposure to digestive and respiratory activities
which may affect the public or the economy.
Medical risks mainly concern patients and even their relatives and healthcare
professionals which may lead to death, temporary or permanent disability, grief
or pain. These risks are to be controlled by professionals in the sector under the
supervision of competent authorities.

Geopolitical risks.

These risks affect the relationship between states or countries of the world. They
are most often caused by the states, who will have to control them. This is the
last level of risk, before climate risks. When it happens, it could cause: Armed
conflicts, trade wars, health disaster, wealthy or health inequality e.t.c

Climatic risks.

Mainly they are risks that affect the climatic changes that could harm the
temperature, water, animals and human being. It could also cause soil pollution,
sea pollution, deforestation e.t.c

Economic risk

Economic risk refers to the amount of risk your organization is at due to shifts in
macroeconomic forces. This includes everything from inflation or policy changes
to interest rates or even employment levels.

Depending on your operating geography, these forces may be local, regional,

national or even global.
Legal or compliance risk

Legal or compliance risk refers to any situation where an organization’s actions

might violate state, local, or federal laws or regulations. Such violations might be
due to data security breaches, product liability, or illegal actions taken by
employees.

Compliance risk management involves identifying potential risks before they

occur. For example, if a company has a new product line, it should immediately
consider potential compliance frameworks that might apply. From there, your
team should take steps to understand what those requirements are and how to
meet them.

Security and fraud risk

Fraud or security risk relates to any event where persons internal or external to
the organization cause harm through deliberate deception. This might include
embezzlement, theft, or other loss of material or reputation.

The most common cases of fraud risk these days are data breaches by a hacker
infiltrating a server, sending a phishing email, or using other malicious tactics.
The best way to combat these sorts of data breaches involves consistent,
continuous training of your employees against the most common tactics.

Financial risk

Also sometimes known as downside risk, financial risk is any potential loss of
money or other assets. A common type of financial risk is market risk, which
occurs when the value of an asset drops because investors' expectations about
future returns differ. Another type that might occur involves currency
fluctuation. Financial risks can cause: Market fluctuation, Currency rate
fluctuation, mismanagement, non-repayable credits e.t.c

For instance, if your business is heavily invested by way of a foreign currency

that is fluctuating wildly due to out-of-control inflation, you might mitigate the
risk by figuring out a way to transition over to a more stable currency. Dealing
with financial risk involves a multi-fold approach: minimizing debt, maximizing
cash flow, and diversifying your client-base.

Reputation risk

Reputation risk is the risk that people will lose confidence in your brand or
product. If customers believe that your company has acted dishonestly or
irresponsibly, it can cause irreparable harm to your organization’s brand in the
market.

Reputation risk could be the result of deliberate action by an organization, but

one of the more common causes, especially lately, is from data breaches.

Data breaches are a surefire way to break trust in the public eye. Security
compliance, meanwhile, is a way to protect data and build trust before it is lost.

Operational risk

Operational risk involves anything that could put a halt to business-as-usual. This
can include everything from a natural disaster, like a hurricane taking a huge
swath of your operations offline, to many key employees being out sick and
unable to contribute their expertise. The best way to manage operational risk is
to have a business continuity plan (BCP) in place for all of the most likely events
that could strike your organization (and maybe even a few that are less likely but
still possible). This way, you’ll already have a plan in place should something
devastating occur.

Competitive risk

Competitive risk refers to the potential loss of customers due to competition. It's
also known as market share risk because it's related to how much of the market
you control. No matter how popular your product or service, technology and
consumer expectations change over time, and in order to reduce competitive
risk, you must be always looking to maintain your competitive edge.

How to conduct a risk assessment

A risk assessment is the identification, assessment, and prioritization of your risk.

This means looking at your assets, people, and IT; understanding weaknesses
where they are exposed; and identifying threats that could exploit those
vulnerabilities. The goal of risk assessment is to uncover the information
necessary to reduce the risk of potentially damaging events in the future.

Which risks are greatest for your company will depend on the specifics of your
business and industry. That’s why it’s vital to regularly conduct risk assessments.
Individuals and organizations need to be proactive in their risk mitigation efforts
so as to reduce the effect of such risks.

Risk management process.

Risk management process involves the underlisted stages:
 Planning Risk Management
 Identify the Risks
 Estimate the Risks
 Controlling the Risks
 Monitoring the Risks

Planning risk management

Initially, it is necessary that individual or organization clearly define the tasks to

be carried out and establish the responsibilities:

The risk acceptance policy (criteria) should be defined by the top management of
the company, and all the other tasks related to risk management should be
clearly defined and described.

Identify the risks

The quality of your analysis will depend directly on your knowledge of the
context, it is advisable to describe it by specifying:
  The people/environment/equipment involved
 The different hazards
 The scenarios leading to the hazardous situations
 The potential harms

After identification of the possible risk, organization should also review the:

 The risks already known,

 The controls already implemented,
 Good practices (guides, standards, specifications, regulations …)
 The technical possibilities and limitations that are associated.

Estimate the risks

This is where things get complicated, you have to estimate – at least

qualitatively if not quantitatively – probabilities and severities, yet:

These estimates concern a huge range from the probabilities that vary from
money loss from harm to health ranging from mere discomfort to death that are
difficult to grasp.

Controlling risks

The idea is to define measures to reduce risks. There are many approaches
available, but they need to be applied in order of effectiveness:

 Total removal of the risk

 Use of means of protection
 Implementation of prevention, through stakeholder information
 Compensation (offset) for the risk if it is not reduced

When to stop controlling risks

This is one of the most delicate point in risk management: knowing when to stop
controlling risks. Risks are considered sufficiently controlled when… your criteria
say so!
There are two approaches:

1. One theoretical: control is stopped when the residual risk is smaller

than a predefined threshold. This is dictated by standards and
regulations.
2. One practical: control is stopped when control is no longer possible
Monitoring the risks

It is crucial to correctly choose the indicators that will enable monitoring known
risks and detecting emerging risks. The definition of indicators is never fixed, it
evolves with your understanding of the risks. The risk observed will reflect the
indicators chosen, with all the problems of imprecision, bias and possible
misinterpretation.
To choose follow-up indicators, you need to consider:

 The needs to improve the estimation of known risks,

 The means to detect emerging risks,
 The availability of indicator on comparable or correlated risks,
 The ease of interpretation of indicators,
 Their form, the means of data collection, the modalities of analysis,
the means of data presentation e.t.c.

What are the principles of risk management?

Risk management principles aim to help your organization improve how it

manages risk, so that you can create and protect value in your organization. The

principles also intend to make your risk management processes

more efficient and effective.

Below are the common principles of risk management that are outlined by the

international standard.

1. Integrated - Ensure that all of your organization’s activities make risk

management a focus. Integrate it throughout your organization.

2. Structured and comprehensive – To achieve consistent results, your

approach to risk management needs to be well-organised and thorough. It

can’t be haphazard or sloppy; this only leads to failures down the line.
3. Customised – Every organization is different. Make sure that your risk

management framework and process is tailored to your organization, the

context in which it operates, and its objectives.

4. Inclusive – Where appropriate, involve stakeholders in the risk

management process. Stakeholders are defined as either a person or

organization that can impact or be impacted by your decisions or

activities. By considering their knowledge, views and perceptions, you can

gain valuable insight to improve awareness and inform risk management.

5. Dynamic – The risk landscape is constantly changing, as is your

organization. Don’t get stuck in a rut. Your organization should be able to

anticipate, identify, acknowledge and respond to all kinds of risks, whether

they are new, changing, or no longer a concern. You must be able to do

this quickly and appropriately.

6. Best available information – A robust risk management process relies

on past and present data, and anticipations for the future, as well as the

limitations and uncertainties surrounding that information. What’s more,

all information must be timely and accessible for stakeholders who need

it.

7. Human and cultural factors – Don’t forget about human behaviour and

company culture, such as your organization’s capabilities and goals, or

stakeholder objectives. Factors like these can significantly impact risk

management, so you must recognize this within your risk management

 activities.

8. Continual improvement – In life, there is always more to learn. The

same is true for risk management. You should always be discovering new

things and, through experience, your approach to risk management should

continually improve.

The benefits of applying the principles of risk management

When principles of risk management are not followed, risk is often approached in

a disorganized manner that can have spiralling consequences. For example, if a

manufacturer does not check the quality of materials from a supplier, they risk

creating a sub-standard product. This could then lead to recalls, replacements,

refunds, machine downtime, delay in re-supply, and ongoing costs to reputation.

By applying the principles of risk management to your organization, it becomes

easier to handle risks like the one just described. You can ensure that:

i. Your approach to risk management is organized rather than

chaotic – this can prevent failures and the higher costs associated with

them, which protects the overall value of your organization

ii. Your organizational risks are managed more easily – poorly

managed risks can often spread further than the initial risk failure and

make matters worse

iii. Your reputation is protected – a poor reputation can result in less new

business and a loss of existing customers, which can be avoided when risk

is managed more effectively

iv. You can identify potential hazards – once identified, you can take

action to mitigate the damage should the risk occur, or remove the risk

completely

v. You can identify possible opportunities – implementing these

opportunities can add value in your organization.

Risks and Return.

A gain made by an investor is referred to as a return on their investment.

Conversely, the risk signifies the chance or odds that the investor is going to lose
money.

What is the difference between investment risk and return?

Investment returns are expressed as a percentage and represent the gain or loss
(factoring in both capital appreciation and income) made on an asset over a
specific period. On the other hand, investment risk is define as the degree of
uncertainty or potential financial loss inherent in an investment decision.

Risk governance structure.

A risk governance structure is a framework which denotes the responsibility,
accountability for management and oversight of risks in an institution.

In order to achieve the effective application of risk management activities, it is

essential for role players in risk management to understand and fully execute
their roles. The successful implementation of risk management activities require
the effective exercising of accountability and oversight functions.
Role Players in risk management in an organization.
The Regulators must prescribe effective guidelines to the public sector
institutions.
The Executive Authorities must ensure that properly established and
functioning policies, structures, strategies and systems of risk management are
in place to ensure that institution attains its operational and strategic objectives.
Accounting Officers/Authorities (such as Head of Department or Manager)
must take all reasonable steps to ensure that the manager has and maintains
effective, efficient and transparent systems of risk management and internal
control.
The Risk Management Committee must assist the Accounting Officer in the
planning, implementation, monitoring and review of an effective and efficient
system of risk management.
The Chief Risk Officer, together with the risk unit, must proactively coordinate
the risk management activities.
Functionally reporting to the Audit Committee, the Internal Audit must assist
the Accounting Officer by offering an independent, objective assurance and
consulting activity designed to add value and improve an institution's operations
by bringing a systematic, disciplined approach to evaluate and improve the
effectiveness of risk management, control, and governance processes.
The Audit Committee must independently review the control, governance and
risk management within the Institution.

What are the risk management structures?

The organization should have a structure for managing wide risks and for the
actual risk work. The framework should include processes for Risk Reporting and
Risk Analysis and is often categorized into: Financial risks (such as liquidity and
credit risks and Non-financial risks (process control).
What are the components of risk management?
Risk governance is the process put in place to enable the organization uncover
potential risks, understand their impact levels and develop risk management
strategies aligned with their profiles.
The core components of a risk management framework are:
 Risk identification.
 Risk measurement.
 Risk reporting.
 Risk monitoring.

Risk Reporting.

Risk reporting is a method of identifying risks tied to or potentially impacting an

organization's business processes. The identified risks are usually compiled into
a formal risk report, which is then delivered to an organization's senior
management or to various management teams throughout the organization.

A risk report is a summary that describes the potential risks a company may
face.

They address critical risks, which have the potential for severe consequences
and emerging risks that become problematic in the future if someone does not
monitor them closely.

Why is risk report important?

Risk reports are important because they help project managers, project owners
and clients better understand various risks the company is taking while working
on a project. Having an accurate and informative report ensures that senior
management knows of existing risks. This knowledge can help a company create
a plan to avoid unwanted surprise and unauthorized actions.

What is a Near Miss?

A near miss is defined as any event that does not lead to harm but does have the
potential to cause illness or injury.

A near miss is a potential accident narrowly avoided, highlighting safety risks.

Week 4 and 5: Understand operational Risk.

At the end of the class, students are expected to understand the following:
**The meaning of operational risk.
**Types of operational risk management.
**Key stages of operational risk management.
**Operational risk management areas.

Operational Risk.

Operational risk is the risk of losses caused by flawed or failed processes,

policies, systems or events that disrupt business operations. Employee errors,
criminal activity such as fraud and physical events are among the factors that
can trigger operational risk.

What Is Operational Risk?

Operational risk summarizes a company's uncertainties and hazards when

attempting to do its day-to-day business activities within a field or industry. A
type of business risk, it can result from breakdowns in internal procedures,
people, and systems—as opposed to problems incurred from external forces,
such as political or economic events, or inherent to the entire market or market
segment, known as systematic risk.

Operational risk management involves addressing potential weaknesses in an

organization’s staff, systems, and internal controls to prevent disruptions and
financial losses.

Causes of Operational Risk

Operational risk usually arises from four different sources: people, processes,
systems, or external events. For many aspects of operational risk, companies
must simply try to mitigate the risk within each category as best as possible
with the understanding that some operational risk will likely always be present.

Below are common causes of operational risks in an organization:

 People.
 Processes.
 Systems.
 External events.

People

Operational risk caused by people can arise due to employee deficiencies or

shortages. For example, a company may not have staff with the knowledge
needed to tackle a specific problem, or it may not have an appropriate number
of employees on hand to properly address peak season or the busier times of
the year.

Companies can simply look to markets to hire staff to mitigate these types of
risks. However, this introduces new people-centric operational risks such as
identifying the appropriate candidates to hire, training staff, and ensuring
employee retention remains high. As each of these aspects is resource- and
time-intensive, operational risks caused by people are heavily tied to financial
repercussions.
Processes

Every company has its own processes. More complex manufacturing

companies (e.g., a vehicle manufacturer) will have different processes than a
service-only law firm. In either case, all companies have steps that must
be performed in sequential order or else detrimental outcomes are possible.

In many cases, especially with companies that have experienced high turnover,
companies may not have fully built out their processes or documented all the
steps. In addition, some processes are also at risk of being taken advantage of
through collusion and failed internal controls, putting the company at risk of
losing money through theft.

Systems

More and more companies are relying on software and systems to operate their
businesses. Operational risk includes the chance that these systems are
outdated, inadequate, or not properly set up. There are also performance
considerations, as operational risk consists of the possibility that one company's
systems aren't as efficient as a competitor's.

There also are operational risks relating to a system's technical aspects.

Systems may have bugs or technical deficiencies, leading to more exposure
to cybercrime. Systems also have capacity constraints, and a company may be
increasing its risk by placing too heavy a load of expectations on what its
systems can do.

External Events

In many cases, operational risk occurs outside the company. This can be
anything from natural disasters that impede a company's shipping process to
political changes that restrict the company's ability to operate. Some of these
types of risk may be classified on their own (e.g., geopolitical risk). Others are
simply a nature of business, such as a third-party defaulting on a contract
agreement.

Common types of operational risks.

 People Risk.
 Process Risk.
 System Risk.
 External Event.
 Legal Risk.
 Compliance Risk.
 Cyber Risk.

What Are the Top Operational Risks for Banks?

Operational risk in the banking system is not a new concept. Only recently,
however, has it been elevated to a distinct risk category that can shape the risk
profiles of financial institutions. This elevation is mainly due to the Basel
Committee on Banking Supervision (BCBS).
In one of its papers, the BCBS defines operational risks for banks as “the risk of
loss resulting from inadequate or failed internal processes, people, and systems,
or external events.”

Since the global financial crisis in 2008, financial institutions have established
advanced systems to control financial risk.

They haven’t been able to deal with operational risk as effectively.

 One reason is that operational risk is more complex, involves many risk
types, and is not always easy to measure.
 Another is that active risk management requires advanced visibility into
diverse processes and activities across the organization.

Top Operational Risks in Banking and Financial Services

New business models, complex value chains, regulatory challenges, and

increasing digitization have created unknown operational risks for banks in
recent years. These include:

Cyber security Risk

Even as financial institutions ramp up their cyber security efforts, cyber risks,
including ransom ware and phishing (when the hackers duplicate or send a fake
mail or information pretending that it emanates from the original customer)
have become more frequent and influential, affecting their operational
continuity.

This is especially true in the post-pandemic world where threat actors leverage
security weaknesses in firms’ IT infrastructure to perpetrate serious cyber-
attacks.

Third-Party Risk

Financial institutions are increasingly relying on third-party providers, which

means they must identify, evaluate, and control third-party risks throughout the
lifecycle of their relationships with those companies. Such companies like the
ATM provider, Telecoms or link suppliers, security supplied, diesel suppliers e.t.c

Internal Fraud and External Fraud

Recent survey reveal that almost 40 percent of mid-sized and large digital
financial services organizations experienced an increase in fraud. Operational
risk losses from internal scams can stem from asset misappropriation, forgery,
tax non-compliance, bribes, or theft.
 Fraud committed by external parties includes check fraud, theft, hacking, system
breaches, money laundering, and data theft. The risk of both internal and
external frauds arises from diverse factors, including the massive growth in
transaction volumes, the availability of sophisticated fraud tools, and the security
gaps created by increasing digitization and automation.

Business Disruptions and Systems Failures

Hardware or software system failures, power failures, and disruption in

telecommunications can interrupt any financial organization’s business
operations and lead to financial loss.

In addition to the operational risks identified above, other risk or loss events
could harm financial companies, increase reputational risk, or lead to legal
problems.

As the financial services landscape becomes increasingly complex, banks and

other financial companies must control operational risk by adjusting their risk
management strategies, systems, and procedures.

Stages of operational risk management.

The key steps in the Operation Risk Management process are:

 Risk Identification
 Risk Assessment
 Risk Mitigation
 Control Implementation
 Monitoring.

Step 1: Risk Identification

Risks must be identified so these can be controlled. Risk identification starts with
understanding the organization’s objectives. Risks are anything preventing the
organization from achieving its objectives.

 Process Analysis: Review internal processes, including production, IT, human

resources, and customer service, to identify potential fail points or
vulnerabilities.
 Loss Data Analysis: Examine historical loss data within the organization to
identify trends and areas of concern. This includes financial losses, data
breaches, compliance violations, and any incidents that disrupted operations.

 Risk Workshop and Interviews: Conduct workshops and interviews with
employees at various levels to gather insights on perceived risks, potential areas
of improvement, and past incidents.
 External Event Analysis: Consider external events and changes in the regulatory
landscape that could impact operations. This includes industry trends,
technological advancements, and geopolitical events.
 Scenario Analysis: Develop hypothetical scenarios to identify potential risks and
their impact. This helps in understanding the organization’s resilience and
preparedness for unlikely but impactful events.

Step 2: Risk Assessment

Risk assessment is a systematic process for rating risks based on likelihood and
impact. The outcome of the risk assessment is a prioritized listing of known risks,
along with the risk owner and risk mitigation plan, also known as a risk register.
It may not be possible or advisable for an organization to address all identified
risks — thus, prioritization is critical for the management of operational risk and
points project teams to the most significant risks. This risk assessment process
may look similar to the risk assessment done by internal audit and should, in
fact, be informed by prior audit reports and findings.
Step 3: Risk Mitigation
The risk mitigation step involves developing and choosing a path for controlling
specific risks. In the Operational Risk Management process, there are four
options for addressing potential risk events: transfer, avoid, accept, and
mitigate.

1. Transfer: Transferring shifts the risk to another organization. The two most
common means for transferring are outsourcing and insuring. When outsourcing,
management cannot completely transfer the responsibility for controlling risk.
Insuring against the risk ultimately transfers some of the financial impacts of the
risk to the insurance company. A good example of transferring risk occurs with
cloud-based software companies. When a company purchases cloud-based
software, the contract usually includes a clause for data breach insurance. The
purchaser is ensuring the vendor can pay for damages in the event of a data
breach. At the same time, the vendor will also have their data center provide
SOC reports showing there are sufficient controls in place to minimize the
likelihood of a data breach.
2. Avoid: Avoidance prevents the organization from entering into a risk-rich
situation or environment. For example, when choosing a vendor for a service, the
organization could choose to accept a vendor with a higher-priced bid if the
lower-cost vendor does not have adequate references.
3. Accept: Based on the comparison of the risk to the cost of control, management
could accept the risk and move forward with the risky choice. As an example,
there is the risk an employee will burn themselves if the company installs new
coffee makers in the break room. The benefit of employee satisfaction from new
coffee makers outweighs the risk of an employee accidentally burning
themselves on a hot cup of coffee, so management accepts the risk and installs
the new appliance.
4. Mitigate: Mitigating risks involves implementing action plans and controls that
reduce the likelihood of the risk and/or the impact it would have if the risk were
realized. For example, if an organization allows employees to work from home,
there is a risk of data leakage due to the transmission of data across the public
internet. To mitigate this risk, management might implement a VPN service and
have remote users access the business network through VPN only. This would
reduce the likelihood of data leakage, thereby mitigating the risk.

We’ve mentioned a few times that very few risks can be eliminated. Noting the
residual risk — the risk remaining after mitigation — is an equally important part
of the risk mitigation phase of Operational Risk Management.
 Step 4: Control Implementation
Once risk mitigation decisions are made, action plans are formed, and residual
risk is captured, the next step is implementation. Controls should be designed
specifically to address and mitigate the risk in question. The control rationale,
objective, and activity should be formally documented so the controls can be
clearly communicated and executed. Controls might take the form of a new
process, an additional approver, or built-in controls that prevent end users from
making errors or performing malicious activities. Whenever possible, controls
should be designed to be preventive, rather than detective or corrective. With
risk management and medicine, it seems the best cure is prevention. That said,
it may be impossible to prevent a risk from occurring, which is where detective
controls come into play. Detecting anomalies and then correcting them may be
sufficient to mitigate certain risks.
Most likely, your organization already has some controls in place to combat risks.
It’s still wise to review those controls on an annual basis (at minimum) and
determine whether additional controls are needed if there are gaps in the
control, or if the control is sufficient to address the risk and requires no changes.

Step 5: Monitoring
Since controls may be performed by people who make mistakes, or the
environment could change, controls should be monitored. Control monitoring
involves testing the control for appropriateness of design, and operating
effectiveness. Any exceptions or issues should be raised to management with
action plans established.
Within the monitoring step in the Operational Risk Management strategy, some
organizations, especially in financial services, have adopted continuous
monitoring or early warning systems built around key risk indicators (KRIs). Key
risk indicators are metrics used by organizations to provide an early signal of
increasing risk exposure in various areas of the enterprise. KRIs designed around
ratios monitored by business intelligence applications are how banks can
manage operational risk, but the concept can be applied across all industries.
KRIs can be designed to monitor nearly any potential risk and send a notification.
As an example, a company could design a key risk indicator around customer
satisfaction scores. Falling customer satisfaction scores could indicate customer
service representatives are not being trained or that the training is ineffective.

These stages are guided by four principles:

1. Accept risk when benefits outweigh the cost.

2. Accept no unnecessary risk.
3. Anticipate and manage risk by planning.
4. Make risk decisions at the right level.

Operational risk management areas.

 Identify the hazards.

 Decide who may be harmed and how?
 Evaluate the risks and decide on control measures.
 Record your findings.
 Review the risk assessment.
Week 6 and 7: Understand Market Risk.
At the end of the class, students are expected to understand the following:
**The meaning of market risk.
**Types of market risk.
**Tools and techniques used in measuring market risk.
**Differentiate between market risk and fraud.
Explain market risk in trading books and banking books.

Meaning of market risk.

What is Market Risk?

The term market risk, also known as systematic risk, refers to the uncertainty
associated with any investment decision. Price volatility often arises due to
unanticipated fluctuations in factors that commonly affect the entire financial
market.

Systematic risk is not specifically associated with the company or the industry
one is invested in; instead, it is dependent on the performance of the entire
market. Thus, it is necessary for an investor to keep an eye on various macro
variables associated with the financial market, such as:

 Inflation.
 Interest rates.
 The balance of payments situation.
 Fiscal deficits.
 Geopolitical factors, etc.

Risk management is the process of identifying and measuring risk and ensuring
that the risks being taken are consistent with the desired risks. The process of
managing market risk relies heavily on the use of models. A model is a simplified
representation of a real world phenomenon. Financial models attempt to capture
the important elements that determine prices and sensitivities in financial
markets. In doing so, they provide critical information necessary to manage
investment risk. For example, investment risk models help a portfolio manager
understand how much the value of the portfolio is likely to change given a
change in a certain risk factor. They also provide insight into the gains and losses
the portfolio might reasonably be expected to experience and the frequency with
which large losses might occur.

Different Types of Market Risk

1. Interest Rate Risk

Interest rate risk arises from unanticipated fluctuations in the interest rates due
to monetary policy measures undertaken by the central bank. The yields offered
on securities across all markets must get equalized in the long run by adjustment
of market demand and supply of the instrument. Hence, an increase in the rates
would cause a fall in the security price. It is primarily associated with fixed-
income securities.

2. Commodity Risk

Certain commodities, such as oil or food grain, are necessities for any economy
and compliment the production process of many goods due to their utilization as
indirect inputs. Any volatility in the prices of the commodities trickles down to
affect the performance of the entire market, often causing a supply-side crisis.

Such shocks result in a decline in not only stock prices and performance-based
dividends, but also reduce a company’s ability to honor the value of the principal
itself.

3. Currency Risk

Currency risk is also known as exchange rate risk. It refers to the possibility of a
decline in the value of the return accruing to an investor owing to the
depreciation of the value of the domestic currency. The risk is usually taken into
consideration when an international investment is being made.

In order to mitigate the risk of losing out on foreign investment, many emerging
market economies maintain high foreign exchange reserves in order to ensure
that any possible depreciation can be negated by selling the reserves.

4. Country Risk

Many macro variables that are outside the control of a financial market can
impact the level of return due to an investment. They include the degree of
political stability, level of fiscal deficit, proneness to natural disasters, regulatory
environment, ease of doing business, etc. The degree of risk associated with
such factors must be taken into consideration while making an international
investment decision.

How to Mitigate Market Risk

Because the risk affects the entire market, it cannot be diversified in order to be
mitigated but can be hedged for minimal exposure. As a result, investors may
fail to earn expected returns despite the rigorous application of fundamental and
technical analysis on the particular investment option.

Volatility, or the absolute/percentage dispersion in prices, is often considered a

good measure for market risk. Professional analysts also tend to use methods
like Value at Risk (VAR) modeling to identify potential losses via statistical risk
management.

The VAR method is a standard method for the evaluation of market risk. The
technique is a risk management method that involves the use of statistics that
quantifies a stock or portfolio’s prospective loss, as well as the probability of that
loss occurring. Although it is widely utilized, the Value At Risk method requires
some assumptions that limit its accuracy.
What are the tools for measuring market risk?
One of the most widespread tools used by financial institutions to measure
market risk is value at risk (VAR), which enables firms to obtain a firm-wide view
of their overall risks and to allocate capital more efficiently across various
business lines.
What is market risk model?
To measure market risk, investors and analysts often use the value at risk
model. Value At Risk modeling is a statistical risk management method that
quantifies a stock's or portfolio's potential loss as well as the probability of that
potential loss occurring.
Difference between Market risk and Credit risk.

Market risk is the risk that arises from movements in stock prices, interest
rates, exchange rates, and commodity prices.

Credit risk is the risk of loss from the failure of a counterparty to make a
promised payment, and also from a number of other risks that organizations
face, such as breakdowns in their operational procedures. In essence, market
risk is the risk arising from changes in the markets to which an organization has
exposure.

Difference between Risk and Fraud.

In finance, risk refers to the degree of uncertainty and/or potential financial loss
inherent in an investment decision. In general, as investment risks rise,
investors seek higher returns to compensate themselves for taking such risks. In
most situations, the higher the risk the higher the expected return on investment
and vice versa.

Fraud is any activity that relies on deception in order to achieve a gain.

Fraud becomes a crime when it is a “knowing misrepresentation of the truth or
concealment of a material fact to induce another to act to his or her detriment”
In other words, if you lie in order to deprive a person or organization of their
money or property, you’re committing fraud.

Why Do People Commit Fraud?

The most widely accepted explanation for why some people commit fraud is
known as the Fraud Triangle. The Fraud Triangle was developed by Dr. Donald
Cressey, a criminologist whose research on embezzlers produced the term “trust
violators.” The fraud triangle comprises of:

 Financial Pressure.
 Opportunity.
 Rationalization

The Fraud Triangle hypothesizes that if all three components are present —
unshareable financial need, perceived opportunity and rationalization — a person
is highly likely to pursue fraudulent activities.
Market risk in trading books.

The main market risk in a trading book is the risk of losing money if the market
price falls. A long position will incur a loss if the price falls; a short position will
lose money if the price rises. In the trading book, such losses are immediately
reflected in profit and loss.

How does market risk impact banks trading books?

A bank’s trading book is define by the regulators as comprising any positions

taken in wholesale markets either to support market making activities or to
benefit itself from short price changes. Bank regulators now require the trading
book to be managed entirely separately from the rest of the bank. This is so that
any losses in the trading book do not impact the rest of the bank or the wider
banking system.

The main market risk in a trading book is the risk of losing money if the market
price falls. A long position will incur loss if the price falls while a short position
will lose money if the price rises. In the trading book, such losses are
immediately reflected in the profit and loss or the income statement.

Week 8 and 9: Understand Investment Risk.

At the end of the class, students are expected to understand the following:
**The meaning of investment risk.
**Types of investment risk.
**Tools and techniques used in measuring investment risk.
**Differentiate between investment and portfolio management.
**Explain buying and selling in portfolio management.

What is an investment risk?

Investment risk in finance refers to the potential for an investor to experience
financial losses when the actual returns from an investment fall short of the
expected returns. It represents the uncertainty of achieving desired outcomes
and the possibility of losing some or all of the capital invested.
Essentially, financial risk is the likelihood of a security’s value decreasing,
leading to losses compared to the expected returns. When you decide to invest,
you inherently accept the associated risk tied to the specific investment
instrument. For example, stocks and mutual funds, while offering higher return
potential, come with a higher degree of risk than more stable options like
government bonds or fixed deposits.

Understanding the nature and extent of investment risk is crucial for making
well-informed financial decisions. Different instruments carry different risk levels,
and aligning investments with your financial goals and risk tolerance helps in
managing this uncertainty effectively. By assessing your risk capacity and
diversifying your portfolio, you can mitigate potential losses while striving to
achieve desired returns over time.

Understanding the meaning of investment risk with an example

The meaning of investment risk is the degree of uncertainty or the potential for
loss inherent in an investment instrument. As such, all investment avenues carry
a certain degree of risk. Generally, the higher the risk quotient of an investment
instrument, the greater its return expectation. In simple words, greater return
expectations compensate for the higher risks involved in a particular investment
instrument. For instance, investing in equity shares of a company is riskier than
investing in government bonds since government bonds have a low chance of
default. However, equity investments also carry the potential for higher returns
compared to government bonds. The risk and return balance of an investment
instrument is assessed based on several factors, like how liquid the investment
is, how fast the investment will grow, and how safe the corpus will be.

Investment risks are generally assessed in historical terms. In other words, how
investment instruments have performed historically and their historical returns.
Investors generally calculate financial risks associated with an asset using
standard deviation. Standard deviation measures the volatility of an asset’s price
relative to its historical average within a given time frame. For instance, a highly
volatile stock will have a high standard deviation, while more stable stocks will
have lower standard deviation values.

Factors that can caused Investment include:

 Economic fluctuations/changes.
 Market volatility.
 Changes in interest rates.
 Political instability.
 Company performance can lead to a decline in the value of securities. It
signifies the chance of losing part or all of your invested capital.
  Adverse market movements or other unforeseen circumstances all of
which can impact the value of securities.

For instance, if the price of a stock or bond falls, the value of the investor's
holdings diminishes, potentially leading to losses. Different types of investments
carry varying degrees of risk; while stocks and mutual funds may offer higher
returns, they are typically riskier than government bonds or fixed deposits.
Understanding investment risk is crucial for making informed financial decisions
and selecting options that align with your risk tolerance and financial goals.

Features of investment risks

The following list of investment risk features will help you better understand
what an investment risk is:
 Uncertainty: Investment risk is the risk of losing your invested principal
due to a fall in the price of the security.
 Relationship with returns: Generally, securities with a higher
investment risk carry a higher return potential. Investors expect higher
returns from assets that have a higher risk quotient.
 Types: Investment risks can be broadly classified into systematic risks
(risks that impact the whole market) and unsystematic (specific risks that
impact a particular industry or a company). Apart from this broad
classification, assets may be subjected to different types of risks, including
market risk, credit risk, reinvestment risk, inflation risk, and liquidity risk.
 Management: While all investment avenues carry different degrees of
investment risks, there are various risk management strategies investors
deploy to minimize uncertainties. Diversification, long-term investment
horizons, and averaging are some common strategies for investment risk
management.

Types of investment risks

Now that you know the meaning of investment risks, let’s look at the different
types of investment risks:
 Market Risk.
 Liquidity Risk.
 Concentration Risk.
 Credit Risk.
 Re-Investment Risk.
 Inflation Risk.
 Horizon Risk.
 Longevity Risk.
 Foreign Investment Risk.
Market risk
Market risks are systemic risks that can impact the whole market or a significant
proportion of the market, resulting in your investment losing value. Market risk
can be subdivided into the following categories:
  Equity risk: This financial risk pertains to share market investments. The
market price of equity shares can fluctuate on the basis of different factors
that affect their demand and supply. Equity risk is the risk of losing
investment value due to a significant drop in the market prices of shares
due to market events or political events.
 Interest rate risk: This is a market that can fluctuate due to various
reasons like inflationary pressures. If the central bank raises interest rates
in the market to combat inflation, the market value of debt securities like
bonds will drop because newly issued bonds will become more attractive.
You may have to sell an older bond with a lower interest rate at a discount
due to limited buyers.
 Currency risk: Currency risk is a market risk you bear when you invest in
foreign markets. The value of your investments can change depending on
the changing exchange rates between the domestic currency and foreign
currency.
Liquidity risk
Liquidity risk relates to the investor’s ability to redeem their investment in the
security for cash. It is the risk of not finding a market for securities, limiting the
investor’s ability to buy and sell the security when they want. Liquidity risk may
arise when there are limited buyers for the security in the market, which may
force you to sell your assets at a lower price, resulting in losses. Liquidity risk can
also arise when assets cannot be easily liquidated due to a mandatory lock-in
period or associated premature withdrawal penalties.
Concentration risk
Concentration risk is the risk of loss you bear when you decide to invest in only
one security or one type of asset class. In such cases, you run the risk of losing
your entire investment if the market value of the selected security declines.
Credit risk
Credit risks are the most common types of investment risks associated with debt
instruments like bonds. Credit risk is the risk that the bond issuer - company or
the government - will default on the payment. Due to financial struggles, the
bond issuer may not be able to pay the principal sum and interest, defaulting on
their payment obligations. Generally, corporate bonds carry a higher credit risk
than government bonds because the government is less likely to default on
payments. Credit agencies issue credit ratings for bonds, underscoring their risk
quotients.
Reinvestment risk
Reinvestment risk is a type of financial risk that arises when you reinvest the
principal or income from the investment at a lower rate of return than the
original return rate. In other words, it is the risk of reinvesting the original
principal or income proceeds at a lower rate and losing out on returns.
Reinvestment risks are most commonly associated with fixed-income assets like
bonds.
Inflation risk
Inflation risk is the risk of losing the purchasing power of your invested funds due
to the steady rise in the cost of goods and services. You have to bear this
financial risk if the rate of return on your investment is lower than the prevailing
inflation rate.
Horizon risk
Time horizon refers to the length of your investment holding period. Horizon risk
is the risk of shortening the investment horizon of an asset you had planned to
hold for the long term. Various factors like job loss or emergency expenses can
force you to liquidate long-term investments early and lose out on potential
returns from a longer holding period.
Longevity risk
As an investor, you also carry a longevity risk. This investment risk refers to the
possibility of you outliving your investment corpus. In other words, your
investment corpus is not sufficient enough to sustain you through the retirement
years. As such, longevity risk is a common risk for retirees and those nearing
retirement.
Foreign investment risk
As the name suggests, foreign investment risk is the risk associated with
investing in foreign markets. Foreign investment risk includes multiple risks,
including the possibility of fluctuating exchange rates, chances of civil or political
unrest, falling GDP, and rising inflation. Any of these events can potentially risk
your entire investment corpus.
How to measure investment risk?
Financial advisors use different statistical tools to measure investment risks
which include:
 Standard Deviation.
 Sharpe Ration.
 Financial Advisors.
Standard deviation is used to estimate how much the price of the asset has
fluctuated against its own average.
Sharpe Ratio is used to estimate if the return on the investment is worth the
risk it carries. Beta measures the amount of systemic risk involved in a particular
security relative to the overall market.
Financial advisors also use Value at Risk as a tool to estimate the investment
risk associated with a particular portfolio.

Estimating your own risk appetite is crucial before you start investing and
measuring risks.

Risk tolerance factors.

Risk tolerance levels of investors vary on the basis of factors such as:
 Age.
  Investment goals.
 Income.
 Liquidity requirements.
Considering these factors will help you gauge how much risk you are willing to
take on. Additionally, you need to consider the risk-return ratio of investment
instruments carefully. As mentioned earlier, riskier investments generally offer
higher returns. However, you must estimate if the returns from the investment
are worth bearing the risks using statistical measures like the Sharpe Ratio.

How to manage investment risks

Each type of investment carries its own set of risks. As an investor, you need to
learn how to manage these risks rather than avoid investing altogether. Here are
a few strategies you can implement to manage investment risks:
 Diversification.
 Investing Consistently.
 Investing for long time.

Diversification
Diversification is the most basic strategy of risk management and minimization.
It is the process of spreading your investments across various asset classes to
create a buffer for your portfolio. Diversification is linked to the concept of
correlation and risk. If you diversify investments across assets with a low or
negative correlation, you can effectively lower your portfolio's risk exposure. The
logic is sound—even if one asset class or industry underperforms, others may
perform better, preserving the overall value of your portfolio. A well-diversified
portfolio that has investments spread across different asset classes like stocks,
bonds, mutual funds, and gold can help you minimize loss potentials.
Additionally, it is important to focus on diversification within each type of
investment, varying investment by sector, industry, and market capitalization.
Investing consistently (averaging)
Averaging is another prudent strategy to manage financial risks. Consistently
investing money at regular intervals at more or less equal amounts over time
can help smoothen the impact of short-term highs and lows.
Investing for the long term
Financial experts believe that long-term investors can earn better returns than
those with a short-term investment horizon. Markets tend to perform better in
the long run, averaging out short-term volatility. Investors prone to impulsive
decisions due to short-term fluctuations fail to realize long-term gains.
Summary.
In summation, investment risk means the possibility of an investment’s actual
return being lower than the expected return, resulting in potential losses. Since
investment risk is a key characteristic of most investment instruments, you
cannot completely bypass these risks. However, as an investor, you can deploy
strategies like diversification to better manage investment risks.

Learning how to manage investment risks can help you better allocate funds and
maximize the risk-to-return quotient of your portfolio. Additionally, if you are a
low-risk investor, you can also add certain guaranteed return investments (which
offer lower returns).

Tools for measuring investment risk.

Overview of Measuring Risk

Investors and financial professionals use various tools to analyze investment

risks. These methods range from basic statistical measures to sophisticated
mathematical models. The most fundamental risk measures, such as standard
deviation and beta, give you a baseline understanding of an investment's
volatility and how that compares to the broader market. Each method has its
strengths, and skilled risk managers usually combine them to build a better,
more comprehensive risk profile.

1. Standard Deviation

Standard deviation is the best-known statistical measure besides mean,

quantifying the dispersion of data from its mean.

In finance, it's frequently used to gauge the historical volatility of an investment

relative to its annual rate of return. For instance, a stock with a high standard
deviation experiences greater volatility, thus making it riskier.

Standard deviation is calculated by dividing the square root of the sum of

squared differences from an investment's mean by the number of items
contained in the data set: √[Σ(x - μ)² / N] where x = each value in the data set, μ
= the mean of the data set, and N = the number of data points.

An alternative to the standard deviation is semi-deviation, which focuses on

downside risk by only considering returns below the mean. This can be
particularly useful for investors who are more concerned about potential losses
than overall volatility.

2. Sharpe Ratio

The Sharpe ratio enables investors to assess how much excess return they're
receiving for the extra volatility of holding a specific asset. A higher Sharpe ratio
indicates better risk-adjusted performance. For example, a Sharpe ratio of 1.5 is
generally considered good, 2.0 is very good, and 3.0 is excellent. But, these
numbers can be relative to the market or sector you're assessing.

The Sharpe ratio is calculated by subtracting the risk-free rate of return from an
investment's total return. Then, divide this result by the standard deviation of
the investment's excess return :(R p - Rf) / σp where Rp = return of the portfolio,
Rf = Risk-free rate, and σp = standard deviation of the portfolio's excess return.

3. Beta

Beta measures a security or sector's systematic risk relative to the entire stock
market. It provides investors a quick way to assess an investment's volatility
compared with a benchmark, typically the broader market.

If a security's beta equals one, the security has the same volatility profile as the
broad market. A security with a beta greater than one is more volatile than the
market. A security with a beta of less than one is less volatile than the market.

Beta is calculated by dividing the covariance of the excess returns of an

investment and the market by the variance of the excess market returns over
the risk-free rate: Covariance (r i, rm) / Variance (rm) where ri = return of the
investment and rm = return of the market.

4. Value at Risk (VaR)

Value at Risk (VaR) is a statistical measure of the potential loss in value of a

risky asset or portfolio in a given period for a given confidence interval.

5. R-Squared

R-squared (R2), also known as the coefficient of determination, represents the

percentage of a fund or security's movements that can be explained by changes
in a benchmark index. For equities, the benchmark is typically the S&P 500,
while the U.S. Treasury bills do this work for fixed-income securities.

Systematic vs. Unsystematic Risk

Risk management is divided into two broad categories: systematic and

unsystematic risk. Both types can affect every investment, though the specific
risks vary across securities.

Systematic Risk

Systematic risk is associated with the overall market. This risk affects every
security, and it is unpredictable and undiversifiable. However, systematic risk
can be mitigated through hedging. For example, political upheaval is a
systematic risk that can affect entire financial sectors like the bond, stock, and
currency markets. All securities within these sectors would be adversely
affected.

Unsystematic Risk

The second category, unsystematic risk, is specific to a company or sector. It's

also known as diversifiable risk and can be mitigated through asset
diversification. For example, should you invest in an oil company, you're
assuming all risks in the company and the broader energy sector.
To protect against unsystematic risk, you might hedge your portfolio by buying
a put option on crude oil or the company. The ultimate goal is to reduce
portfolio-wide exposure to the oil industry and the specific company.

What do you mean by investment and portfolio management?

Portfolio management is the art of selecting and overseeing a group of

investments that meet the long term financial objectives and risk tolerance of a
client/investor, a company or institutions. Some individuals do their own
investment portfolio management.
Some individuals do their own investment portfolio management. This requires
an in-depth understanding of the key elements of portfolio building and
maintenance that make for success, including asset allocation, diversification,
and rebalancing.

Understanding Portfolio Management

Professional licensed portfolio managers work on behalf of clients, while

individuals can build and manage their own portfolios. In either case, the
portfolio manager's ultimate goal is to maximize the investments' expected
return within an appropriate level of risk exposure.

Portfolio management requires the ability to weigh the strengths and

weaknesses, opportunities and threats of a spectrum of investments. The
choices involve trade-offs, from debt versus equity to domestic versus
international and growth versus safety.

Who Uses Portfolio Management

Portfolio management is a critical investment practice used by two types of

entities:

 Individual Investor.
 Institutional Investors.

These categories have distinct strategies, goals, and resources. Understanding

the different approaches and needs of these two types of investors can provide
greater insight into how portfolio management techniques are applied across
the financial spectrum.

Individual investors often focus on personal wealth and future needs, managing
smaller amounts of money with varying degrees of professional assistance. In
contrast, institutional investors manage large-scale assets with a professional
approach tailored to fulfill specific financial obligations and institutional goals.
Both groups, however, aim to improve their returns by managing their portfolios
to tailor them for specific circumstances and financial objectives.

Individual Investors
Individual investors have a range of personal goals, risk preferences, and
resources. Their objectives include saving for retirement, accumulating wealth
for large purchases, funding education for children, or building an emergency
fund. Each goal requires a different strategy or risk profile.

The risk tolerance as well as investment knowledge among individual investors

varies greatly. In addition, their approach to managing investments can range
from highly engaged active trading and rebalancing to relying on automated or
professional management. As financial markets have evolved and technology
has widened access to investment information, individual investors have had
wider prospects to tailor their investment strategies to meet their personal
financial objectives.

Institutional Investors

Institutional investors are entities that pool large sums of money and invest
those funds into various financial instruments and assets: pension funds,
endowments, foundations, banks, and insurance companies. Each has specific
objectives and constraints that influence their portfolio management strategies.
Many institutional investors have long-term financial obligations that cause
them to focus on long-term growth and sustainability over short-term gains.

In addition, institutional investors are often under strict regulatory oversight to

ensure they manage their beneficiaries' funds responsibly. Moreover, ethical
and social governance issues increasingly influence their investment
decisions. Risk management is a crucial part of the work of an institutional
portfolio manager since these entities must balance the need for profitability
with the imperative of preserving capital to meet future liabilities.

Institutional investors' investment approaches are typically conservative

compared with individual investors, focusing on long-term stability, capital
preservation, and meeting future obligations. Indeed, each type of institutional
investor has distinct strategies and objectives, but all share the common goal of
responsibly managing large pools of capital to meet the needs of their
stakeholders.

Common Portfolio Management Strategies

Every investor's specific situation is unique. Therefore, while some investors

may be risk-averse, others may be inclined to pursue the greatest returns (while
also incurring the greatest risk). Very broadly speaking, here are several
common portfolio management strategies an investor can consider:

 Aggressive: An aggressive portfolio prioritizes maximizing the potential

earnings of the portfolio. Often invested in riskier industries or unproven
alternative assets, an investor may be willing to risk losses. Instead,
investors are looking for a "home run" investment by striking it big with a
single investment.
 Conservative: Meanwhile, a conservative portfolio relates to capital
preservation. Extremely risk-averse investors may adopt a portfolio
management strategy that minimizes growth but also minimizes the risk
of losses.
  Moderate: A moderate portfolio management strategy blends an
aggressive and conservative approach. In an attempt to get the best of
both worlds, a moderate portfolio still invests heavily in equities but also
diversifies and may be more selective in what those equities are.
 Income-oriented: Often the option of choice for retired investors, this is
for those who wish to live in part off their portfolio returns. These returns
could come from bond coupons or dividends.
 Tax efficiency: As discussed above, investors may be inclined to focus
primarily on minimizing taxes, even at the expense of higher returns. This
may be especially important for high earners who are in the highest
income tax bracket. This may also be a priority for young investors who
have a very long way until retirement.

Challenges of Portfolio Management

 Whatever strategy is chosen, portfolio management always faces several
hurdles that often can't be eliminated entirely. Even if an investor has a
foolproof portfolio management strategy, investment portfolios are
subject to market fluctuations and volatility. The best management
approach can still suffer from significant losses.

 Though diversification is an important aspect of portfolio management, it

can also be challenging to achieve. Finding the right mix of asset classes
and investments to balance risk and return requires an in-depth
understanding of the market and the investor's risk tolerance. It may also
be expensive to buy a wide range of securities to meet the desired
diversification.

 To devise the best portfolio management strategy, an investor must first

know their risk tolerance, investment horizon, and return expectations.
This requires a clear short-term and long-term goal. Because life
circumstances can quickly and rapidly change, investors must be mindful
of how some strategies limit liquidity or flexibility. In addition,
the IRS may change tax regulations, forcing you to change your
investment strategy.

 Lastly, portfolio managers charge fees. The portfolio manager must often
meet specific regulatory reporting requirements, and managers may not
have the same views of the market as you do.

 How Do I Determine My Risk Tolerance?

 Determining your risk tolerance involves assessing your willingness and
ability to endure market volatility and potential losses. This can be
influenced by your financial goals, investment time horizon, income, and
personal comfort with risk. Tools like risk tolerance questionnaires can
help quantify your risk tolerance by asking about your reactions to
hypothetical market scenarios and your investment preferences. In
addition, thinking back to your past investment experiences and
consulting with a financial advisor can provide a clearer understanding of
the kinds of investments that are right for you in terms of your risk
tolerance.
What Is Asset Allocation?
Asset allocation involves spreading the investor's money among different asset
classes so that risks are reduced and opportunities are maximized. Stocks,
bonds, and cash are the three most common asset classes, but others include
real estate, commodities, currencies, and crypto. Within each of these are
subclasses that play into a portfolio allocation.

What Should I Do If My Portfolio Has Significant Losses?

If this happens, it's important to avoid panic selling and instead assess the
situation calmly. Start by reviewing your investment strategy to ensure it still
aligns with your long-term goals and risk tolerance. Consider whether the losses
are because of market volatility or fundamental changes in the assets you hold.
Rebalancing your portfolio might be necessary to maintain your desired asset
allocation. Diversifying your investments can also help mitigate future risks.
Consulting with a financial advisor can give you guidance and help you make
informed decisions about how to recover from your losses and adjust your
strategy if needed.

How Do I Evaluate How My Portfolio Is Doing?

Evaluating the performance of your portfolio involves comparing its returns
against benchmarks (typically indexes that offer a mix like you're aiming for in
your portfolio) and considering your investment goals. Data to review include
total return, your risk-adjusted return, and the performance of individual assets
relative to their respective indexes. It's also important to review the consistency
of your returns over time and whether your portfolio is making progress toward
your objectives.

**** Portfolio Management

To make the most of one’s investment portfolio investors must participate

actively in portfolio management. By doing so, they will not only be able to
cushion their resources against market risks but will also be able to maximise
their returns successfully.

What is Portfolio Management?

Portfolio management’s meaning can be explained as the process of managing

individuals’ investments so that they maximise their earnings within a given time
horizon. Furthermore, such practices ensure that the capital invested by
individuals is not exposed to too much market risk.

The entire process is based on the ability to make sound decisions. Typically,
such a decision relates to – achieving a profitable investment mix, allocating
assets as per risk and financial goals and diversifying resources to combat
capital erosion.

Primarily, portfolio management serves as a SWOT analysis of different

investment avenues with investors’ goals against their risk appetite. In turn, it
helps to generate substantial earnings and protect such earnings against risks.

Objectives of Portfolio Management

The fundamental objective of portfolio management is to help select best

investment options as per one’s income, age, time horizon and risk appetite.

Some of the core objectives of portfolio management are as follows –

 Capital appreciation

 Maximising returns on investment

 To improve the overall proficiency of the portfolio

 Risk optimisation

 Allocating resources optimally

 Ensuring flexibility of portfolio

 Protecting earnings against market risks

Nonetheless, to make the most of portfolio management, investors should opt for
a management type that suits their investment pattern.

Types of Portfolio Management

In a broader sense, portfolio management can be classified under 4 major types,

namely –

 Active portfolio management

In this type of management, the portfolio manager is mostly concerned with
generating maximum returns. Resultantly, they put a significant share of
resources in the trading of securities. Typically, they purchase stocks when they
are undervalued and sell them off when their value increases.

 Passive portfolio management

This particular type of portfolio management is concerned with a fixed profile

that aligns perfectly with the current market trends. The managers are more
likely to invest in index funds with low but steady returns which may seem
profitable in the long run.

 Discretionary portfolio management

In this particular management type, the portfolio managers are entrusted with
the authority to invest as per their discretion on investors’ behalf. Based on
investors’ goals and risk appetite, the manager may choose whichever
investment strategy they deem suitable.

 Non-discretionary management

Under this management, the managers provide advice on investment choices. It

is up to investors whether to accept the advice or reject it. Financial experts
often recommended investors to weigh in the merit of professional portfolio
managers’ advice before disregarding them entirely.

Who Should Opt for Portfolio Management?

The following should consider portfolio management –

 Investors who intend to invest across different investment avenues like

bonds, stocks, funds, commodities, etc. but do not possess enough
knowledge about the entire process.

 Those who have limited knowledge about the investment market.

  Investors who do not know how market forces influence returns on
investment.

 Investors who do not have enough time to track their investments or

rebalance their investment portfolio.

To make the most of the managerial process, individuals must put into practice
strategies that match the investor’s financial plan and prospect.

Ways of Portfolio Management

Several strategies must be implemented to ensure sound investment portfolio

management so that investors can boost their earnings and lower their risks
significantly.

Professionally, below are the ways to manage investment portfolio:

 Asset allocation.
 Diversification.
 Rebalancing.

 Asset allocation

Essentially, it is the process wherein investors put money in both volatile and
non-volatile assets in such a way that helps generate substantial returns at
minimum risk. Financial experts suggest that asset allocation must be aligned as
per investor’s financial goals and risk appetite.

 Diversification

The said method ensures that an investors’ portfolio is well-balanced and

diversified across different investment avenues. On doing so, investors can
revamp their collection significantly by achieving a perfect blend of risk and
reward. This, in turn, helps to cushion risks and generates risk-adjusted returns
over time.
  Rebalancing

Rebalancing is considered essential for improving the profit-generating aspect of

an investment portfolio. It helps investors to rebalance the ratio of portfolio
components to yield higher returns at minimal loss. Financial experts suggest
rebalancing an investment portfolio regularly to align it with the prevailing
market and requirements.

Once investors have selected a suitable strategy, they must follow a thorough
process to implement the same so that they can improve the portfolio’s
profitability to a great extent.

The fact that effective portfolio management allows investors to develop the best
investment plan that matches their income, age and risks taking capability,
makes it so essential. With proficient investment portfolio management,
investors can reduce their risks effectively and avail customised solutions
against their investment-oriented problems. It is, thus, one of the inherent parts
of undertaking any investment venture.

Portfolio management involves building and overseeing a selection of assets

such as stocks, bonds, and cash that meet an investor's long-term financial
goals and risk tolerance. Active portfolio management requires strategically
buying and selling stocks and other assets to beat the broader market's
performance.

How to Buy and Sell Stocks

Buying stocks is quick and straightforward once you have a brokerage account.
Learn how with this step-by-step guide.
Buying stocks may seem complex, but it's as easy as opening an investment
account online and then purchasing stocks of the companies you're interested in.
Creating long-term wealth from investing is a bit more complicated.

How to buy stocks in 6 steps

To buy stocks, open a brokerage account (also known as an investment

account), add money to the account and then buy stocks from there. You can
open an online brokerage account in about 15 minutes.
Once you have an investment account, buying stocks is pretty straightforward.
Here are the steps to help you understand how to buy stocks:
i. Open an investment account.
ii. Research the stocks you want to buy.
iii. Decide how many shares to buy.
iv. Buy stocks using the right order type for you.
v. Optimise your portfolio.
vi. Learn when to sell stocks and when not to sell.

1. Open an investment account

The easiest way to buy stocks is through an online stockbroker. These companies
allow you to open an investment account. After opening and funding your
account, you can buy stocks through the broker’s website in a matter of minutes.
Other options include using a full-service stockbroker, or buying stock directly
from the company.
Opening an online investment account (also known as a brokerage account) is as
easy as setting up a bank account: You complete an account application, provide
proof of identification and choose whether you want to fund the account by
mailing a check or transferring funds electronically.
There are several types of investment accounts, and some come with additional
tax benefits. Check out the various types of accounts to make sure your
investments will have the most tax-advantaged home.

2. Research the stocks you want to buy

Once you’ve set up and funded your investment account, it’s time to dive into
the business of picking stocks. A good place to start is by researching companies
you already know from your experiences as a consumer.
Don’t let the deluge of data and real-time market gyrations overwhelm you as
you conduct your research. Keep the objective simple: You’re looking for
companies of which you want to become a part owner.
Warren Buffett famously said, “Buy into a company because you want to own it,
not because you want the stock to go up.” He’s done pretty well for himself by
following that rule.

3. Decide how many shares to buy

You should feel absolutely no pressure to buy a certain number of shares or fill
your entire portfolio with a stock all at once. Consider starting with paper
trading, using a stock market simulator, to get your feet wet. With paper trading,
you can learn how to buy and sell stock using play money. Or if you're ready to
put real money down, you can start small — really small. You could consider
purchasing just a single share to get a feel for what it’s like to own individual
stocks and whether you have the fortitude to ride through the rough patches
with minimal sleep loss. You can add stocks over time as you master the
shareholder swagger.

4. Buy stocks using the right order type for you

Don’t be put off by all those numbers and nonsensical word combinations on
your broker's online order page. Refer to this cheat sheet of basic stock-trading
terms.