Business, Legal & Accounting Glossary
The potential negative result of an event, activity, or action.
A situation involving exposure to danger.
n. chances of danger or loss, particularly of property covered by an insurance policy or property being used or transported by another. Insurance companies assume the risk of loss and calculate their premiums by the value and the risk based on statistically determined chances. A trucking company assumes the risk of loss while carrying goods.
Risk is the chance that an investment’s actual return will be different than expected. This includes the possibility of losing some or all of the original investment.
Risk has two components:
If either is not present, there is no risk.
Suppose a man jumps out of an aeroplane with a parachute on his back. He may be uncertain as to whether or not the chute will open. He is taking risk because he is exposed to that uncertainty. If the chute fails to open, he will suffer personally.
Now suppose the man jumps out of the plane without a parachute on his back. If he is certain to die, he faces no risk. Risk requires exposure and uncertainty.
A synonym for uncertainty is ignorance. We face risk because we are ignorant about the future. After all, if we were omniscient, there would be no risk. Because ignorance is a personal experience, risk is necessarily subjective. Consider another example:
A man is heading to the airport to catch a flight. The weather is threatening, and it is possible the flight has been cancelled. He is uncertain as to the status of the flight and faces exposure to that uncertainty. His travel plans will be disrupted if the flight is cancelled. Accordingly, he faces risk.
Suppose a woman is also heading to the airport to catch the same flight. She has called ahead and confirmed that the flight is not cancelled. She has less uncertainty and faces lower risk.
In this example, there are two individuals exposed to the same event. Because they have different levels of uncertainty, they face different levels of risk. Risk is subjective.
Risk is a personal experience, not only because it is subjective, but because it is individuals who suffer the consequences of risk. Although we may speak of companies taking risk, in actuality, companies are merely conduits for risk. Ultimately, all risks which flow through an organization accrue to individuals—stockholders, creditors, employees, customers, board members, etc.
Risk is usually measured by calculating the standard deviation of the historical or average returns of a specific investment.
Many companies now allocate large amounts of money and time in developing risk management strategies to help manage risks associated with their business and investment dealings. A key component of the risk management process is risk assessment, which involves the determination of the risks surrounding a business or investment.
Market risk is the variability or standard deviation of the sum of the securities in any market. Market risk comes from forces (dangers) that affect all businesses – not just one company or one industry.
Market risk is also known as undiversifiable risk or systematic risk.
Unique risk is the risk that can be eliminated by diversification. Unique risk is attributable to the fact that many of the risks a company can face are specific to that company and possibly its competitors. These risks are therefore minimized through diversification, which is essentially diluting the effect these risky securities may have.
Unique risk can also be called diversifiable risk, residual risk, specific risk, or unsystematic risk.
Investors know there is a risk of losing money in any new venture, so they do quite a bit of research before committing funds to a company.
There is a risk of theft from warehouses that are left unguarded, though that is somewhat covered by property insurance.
Why risk your life?
To help you cite our definitions in your bibliography, here is the proper citation layout for the three major formatting styles, with all of the relevant information filled in.
Definitions for Risk are sourced/syndicated and enhanced from:
This glossary post was last updated: 30th April, 2020 | 15 Views.