Risk Management

Globalization have made world more and more integrated. With free execution of trade between countries, prices of commodity not impacted by selected few but almost all major economies, interest rate change in one country impacting through out the world have made risk management more and more important over time and important part of strategy of export houses and businesses who are highly dependable on imports.

I will start my discussion by classifying risk into two categories like known risk and unknown risk. Some people have also introduced terms like lesser known risk. Known are risk which are pretty much known and whose impact can be estimated using sensitivity analysis on portfolios of securities or business products while other form of risk cannot be measured directly. Known risk can be measured hence can be mitigated by following hedging techniques while unknown can't be measured with high confidence hence hedging techniques are also not well defined.

Let us take few examples of various risk in various domains.

IT:

Major risk to IT companies are exchange rate movement, they are highly dependent on value of rupee, other risk they face are attrition,knowledge drain , competition which are business risk which we will not discuss here. Exchange rate of rupee is by product of number of factors like interest rate of countries, foreign exchange flows, current/capital account deficit. Risk manager in IT firm need to account for all these factors while measuring exposure of their business in respect to different countries

Banks:

Banks are in business of exchanging money where they take deposits and give away loan , hence making money on rate difference called as interest margin. Biggest risk they face comes on the amount of loan given to borrowers called as credit risk, if borrower default bank have to pay money from their own pocket. Other big factor is interest rate movement , since major part of bank income comes from interest rate, small change in interest rate can change the whole balance. These two risk need to be accounted in a manager's strategy for banks to stay in the competition. Another form of risk banks face are operational risk, also called risk due to failure of systems/people/natural calamity.

Here in this blog we will talk about risk management for financial companies with focus on

• Credit Risk

• Market Risk

• Operational Risk

Before starting on measurement and mitigation of risk, let us take a look at portfolio management and basic techniques used for portfolio optimization.

Note : Through this blog Indian stock market data will be analyzed and R Language(it is free and works well on my PC) will be used as primary statistical tool.