The risk faced by each organization. Examples of risks are likely to be damaged by fire, changes in interest rates and loss of reputation. Although an organization may to some extent control most of the risks, she is forced to resort to the financing of their effects and the risks that are beyond its control.
Before proceeding to a detailed study of the mechanisms of financing risk, it is necessary to define the terms "risk", "damage" and the loss suffered. The term "risk» (risk) insurance is understood as the probability deviation from the expected outcome.
The risk may lead to unexpected losses, and often unexpected win. Damage (Loss) - any outcome that reduces the financial assessment of the organization or its financial position deteriorates. Examples of damage can be damage to the property of the organization or the increase in costs of materials used in the manufacturing process.
Exposure to loss, or risk (Risk Exposure) , is the possibility of such losses, the destruction of the building where the organization is located, a fire or an increase in market prices for raw materials. Such risky circumstances as a possible rise or fall in interest rates, can equally bring the organization as a benefit and harm.
Organization at risk from many sources. Company engaged in investment in capital assets, as exposed as the real cash flows from capital investments may not meet the expectations of the company.
Some types of risk are under control of the organization, while the other - it is. Although adverse financial characteristics usually attributed to poor management, they may actually be the result of uncontrolled risk managers, as growth in market prices of raw materials for the production of products that the company sells. For example, the rise in world oil prices increases the cost of refining companies and reduces their profit margins.
While most of the risks to organizations bring direct damage, some of the risks associated with the loss of profits. For example, an organization may delay the decision to modernize its product in accordance with market demand, resulting in lost market share and profits that could bring this product. Another example of a loss of profit - output delay of many brokerage firms in the online trading systems.
Since losses are due to the risk organizations face uncertainty about the probability of occurrence of a loss and its severity. The organization shall manage the risk of loss because the loss can reduce its net income, shareholders' equity (the value of assets minus liabilities) and cash flows. The methods used to control the risk of loss include avoidance (evasion), control, diversification, retention (conservation) and the transfer of risk.
Many financial instruments, including insurance, enable organizations to transfer their risks and the resultant damage. The key question for most organizations is not in how much risk the organization can convey, but rather how it should be referred to in order to maximize return on capital. For example, such financial services organizations, such as banks bear the risk of non-repayment of funds. At the same time they have access to a row of financial instruments, which are called "derivatives" or derivative securities (the essence of which we will discuss later). These tools allow the bank to eliminate some of the risk, or even all of the risks.
However, any financial instrument has a specific price. Therefore, the bank maximizes its profits by holding and managing certain level of risk, which provides sufficient return on capital.
