Risk and its Importance Coursework Example | Topics and Well Written Essays - 2000 words

Risk and its Importance - Coursework Example Essentially a company is indulging into risk management if it is actively analyzing and attempting to quantify the possible losses in a business decision or an investment and then is taking appropriate action to mitigate the possibility of those losses occurring. It is fairly important to manage risk in an investment appraisal process as it helps the organization in protecting itself from all kinds of risks; it helps the organization’s customers from large non-market related losses such as a firm failure or fraud. A strong risk management process does not only help the organization, but it also provides security to the overall industry. Importance of risk management can also be gauged by some recent crisis that has happened due to loopholes present in risk management strategies of a few companies. The financial meltdown of 2008 is a key example. b) Measuring risk and incorporating risk in an investment opportunity Risk management is now an essential part in all the businesses as more and more businessmen are facing the repercussions of a poorly managed business decision in terms of risk. With the financial crisis slowly recovering, it is harder for people to now ignore the importance of risk. Predominantly, risk is considered to be a negative term. It is the probability of a result deviating from its forecast, usually towards the negative side. Therefore, it is predominantly considered negative. However, in investment and financial terms, risk is always associated with return. The more risk a person or an entity is willing to take, the more the return is expected. Understanding risk today is perhaps one of the most important things in financial education and financial market. Its importance cannot be stressed more. A deviation from expected outcome can both be negative as well as positive. Therefore, the idea of ‘no pain, no gain’ works in harmony with this situation. If one is willing to undertake a certain amount of losses to ensure that t hey are the winner in the end in terms of returns, they are effectively managing their risk. Measuring risk in absolute terms is done through standard deviation. It is the basic tool for understanding the deviation of an outcome from a central tendency. A lot of other techniques are used; tools are incorporated in order to measure risk of an investment opportunity. There are a number of models through which firms decide upon the nature of risk that an investment opportunity might have. VaR is another tool; value at risk defines how bad things can go and its probability giving a certain level of confidence for a given amount of time. This helps to identify the potential losses that an investing entity might have if they take a certain decision, taking time and confidence of calculations into account. Incorporating risk in an investment opportunity is through taking into account the impact of risk on the outcome of the investment. Critical questions should be answered as the start of the investment appraisal such as the time, the expected return on investment or if the money invested could be used better in another investment opportunity. Beta is another measure through which risk associated with two different investment opportunities is measured. It is specific for a specific kind of project (Jackson, 2008).