Risk management includes all the processes that are used for identifying, analyzing, and either accepting or mitigating the risks that make decision making in investments uncertain. Essentially, risk management is an ongoing process. It can occur any time, especially when a fund manager or an investor is analyzing and attempting to quantify the losses that may be incurred if the investment is made.
Moreover, it not only assesses the risks associated with the investment, but also decides on the appropriate actions that may be taken to mitigate the risk taking into consideration, the risk tolerance, and the objectives of investment. If not done adequately, it may results in some severe consequences that can cause heavy losses to entire organizations, as well as, individuals. For example, the loose credit risk management done by the financial firms was the major cause of the recession beginning in 2008.
To put it in simple words, risk management consists of two basic steps: determine the risks associated with the investment you are planning to make, and then handle the risk in a way that is best suited to the objectives of investment you have. Risk management is an integral part of the financial world, and occurs everywhere from small organizations to large corporations.
There are many instruments that are used by the companies to assess risks. Market risk, and credit risk are the two main types of risks that are associated to any investment, which is why keeping an eye on these, and devising ways that can help you mitigate these risks is an important part of financial planning.
Risk management may be quantitative or qualitative. Risk management, when it comes to investments, however, takes into account the quantitative aspect of risks more than the qualitative ones. Devising proper strategies to alleviate the risks associated with any investment is one of the integral parts of risk management. Risk management, if not done right, can lead to major financial losses that become difficult to cope up for an organization.
Owing to the importance of risk management, organizations tend to spend large sum of money to make sure the risks are alleviated, and the investments are as risk free as possible.