Objectives and the Main Techniques Used in Risk Analysis - Essay Example

Objectives and the main techniques used in risk analysis Insert Name Course, Class, Semester Institution Instructor Date Introduction Risk analysis is a crucial concept that permeates across the entire business discipline. Risk is the aspect that tags along many of the business transactions due to uncertainty. Risk is thus the possibility that a certain action or inaction will amount to aloss. It is hence evident that all endeavors harbor some aspect of risk and thus the only difference is that activities are riskier than others. For investors, risk is crucial as there is an investment tenet that asserts that there is a prevalent relationship between risk and reward. That is to imply that the higher the risk undertaken, the higher the rewards to be attained. Risk thus plays a significant role in shaping the entire business fraternity. For both investors and other businessmen to thrive in the modern dynamic world of business, it is essential that the risk is evaluated so as to create awareness on the magnitude of risk involved (Brigham & Houston, 2009). In addition, risk analysis will harness the decision making process as the decision maker will be accorded with all facts necessary with regards to the risk in question. Risk analysis is hence an essential aspect of the business world. This paper seeks to critically evaluate the objectives of risk analysis and the main techniques used to harness risk analysis. Types of risk Risk analysis is an essential business tenet that has to be differentiated according to the different types of risk. Due to the various types of risk emanating in the business world, the risk analysis techniques will be adopted. For instance there is default risk which is the risk that a financial obligation will not be honored as and when it falls due. It is the risk that a financial debtwill not be paid. Interest rate risk on the other hand has two concepts. Interest rate risk is classified into price risk and reinvestment risk. Price risk is the risk that prices of commodities will change due to changes in the prevailing interest rates. This is explained as a change in the interest rate that in turn leads to a change in the discount rates thus affecting the futures expected cashflows. Reinvestment risk on the other hand is the risk that due to the prevailing changes in interest rates the cash flows gotten from reinvestment will fluctuate from the earlier expected returns. Another type of risk is the liquidity risk, is the risk that an asset might not be easily disposed easily. A highly liquid asset will imply that an asset can be easily disposed within a very short notice. Inflation risk on the other hand is an element of a currency losing value due to inflationary tendencies. This implies that the purchasing power risk will be directly impacting the level of price in the economy. Market risk is also referred to as systematic risk beta or undiversifiable risk (Conrow, 2003). This risk affects the market portfolio and thus should be discussed by various investors. There is also the aspect of financial risk. This implies that there are certain implications that arise due to the financial methods adopted hence there arises a variance in the profits availed by an organization. There is also an overall business risk that arises dueto the prevailing business environment where the business exists. There is also the aspect of project risk. Project risk is the risk that is associated with the implementation investment projects and is apportioned between systematic and unsystematic risk. Finally, there is the foreign exchange risk. This is the risk that emanates from the fact that, the foreign currency might fluctuate in value due to prevailing changes in the economy. There is also a classification of the foreign risk. For instance there is the translation risk which emanates from the translation of the foreign currency financial statement to the home currency. The translation risk is thus the risk that the foreign currency might lose in value or appreciate and as such should be critically evaluated. Generally, the foreign risk affects the multinational corporations or other corporations with subsidiaries in other areas of the international scene. Transaction risks on the other hand, imply that the transactions between foreign and home currency will be affected by the changes in foreign currency values (Pitblado, 1995). The objectives of risk analysis The sole objective of risk analysis is to mitigate the impact of risk and to ensure that the impact caused by risk is reduced and as such, the overall organization's objectives are enhanced. On the other hand, the disparity in the form of risk makes it rather difficult to undertake risk analysis. Risk is apportioned between pure and speculative risk. Pure risk implies that the eventuality of an occurrence will cause losses in totality for instance the outbreak of a fire. On the other hand, the speculative risk is the aspect of uncertainty which results from the unpredictable future events. Generally, risk analysis will seek to ensure that risk is mitigated to the minimum acceptable level that can be adopted by an organization or an individual investor. It is also apparent that, risk analysis will harness a business operational tenet according such a business with a competitive advantage over competitors in the same industry. For the individual investor, risk analysis will help avert all the unnecessary risks that would hence improve on the profitability of the portfolio (Vose, 2008). The process of risk analysis Generally risk analysis is a process in the organization setting that is implemented in the event that there are complex risk issues that need to be sorted. The first step in the risk analysis is the identification of threats. At this stage the entire organization will indulge in the risk identification mission where the threats facing the organization will be identified and the proper measures will be adopted that will in turn ensure the organizations' missions will be eventually attained. Employees and other stakeholders will be indulged in this vigorous process which seeks to identify the risks facing the organization. In instances when the organization is a member of trade unions or other associations, it would be important to involve them in the risk identification mission. In addition, the manufacturer’s guide and other company material should be thoroughly evaluated to help identify as to whether the organization has eminent risks posed to it. It is also important to thoroughly scrutinize the policies in the organization and try to unearth threats, hazards or risks in the organization. The following step will includedeciding on the impact the identified risks will have on the organization (Penza &Bansal, 2000). For each risk, it is important to identify the final impact it might have on the organization as well as the who might be harmed in the eventuality that the risk materializes. This will necessitate the groups be listed and identify the potential; harm that may befall any of the groups just in case the risk was to occur. This will thus ensure that the potential risks and their final resting place are well known in the organization. The third step will include evaluating the risks and deciding among alternative precautions. Having identified the threats as well as the final resting place, it is essential to decide on the appropriate measure that should be put in place. This is achieved by establishing what the organization is currently doing and what needs to be done in the coming future to negate the impact of the risks. Measures like risk reduction, transfer of risk or risk elimination can be implemented to control the situation. The third step essentially seeks to evaluate what can be done amid the challenges in place. Record the findings then implement the feasible strategy is the fourth step. The risk analysis alternatives in the previous steps will be implemented at the fourth stage. The risk analysis steps will also be documented in continuous prose which will facilitate easy revision of the steps in future. The final step will be to review the risk assessment and where necessary, updates should be undertaken. The final stage of the risk analysis process will be to ensure that the above steps were clearly followed and implemented. At this stage, any correction or change that needs to be undertaken in the risk analysis process will take place in the fifthstage. Techniques used in risk analysis Risk is diverse just as the business world is diverse and dynamic. However, the most common technique adopted by corporations is the use of sensitivity analysis. This is the policy that many corporations implement to mitigate the impact of risk. This technique seeks to evaluate the impact the certain variables have on the profitability of the organization. The sensitivity analysis greatly utilizes the net present value analysis in its implementation. The scenario analysis and the Monte Carlo simulation method are adopted by certain organizations. In the case of foreign risk, the most appropriate technique is hedging (Chan-Lau, 2005). Conclusion It isapparent that risk is eminent in organizations in the modern business world. Another notable fact is the issue that risk is an integrated terminology in the business world. This implies that businesses cannot thrive in the exception of risk. As such it calls for the business fraternity to develop [up ways on how the risk impact can be contained. From this, the risk analysis process has been formulated and implemented in organizations to ensure that the risk impact is contained. A process of risk analysis involves various stages which include; identification of risk, formulation of possible alternatives that can be adopted to combat the eventuality of the risk. The third steps involve choosing the feasible process that can be adopted and finally implementing and documenting the risk mitigation technique. Risk analysis has enormous benefits if it is correctly implemented in the organization. In addition, investors also garner much benefit through adoption of the right risk analysis process. The business fraternity should in future indulge in new techniques hence mitigation the foreign currency risk amid other risks prevalent in the business discipline. References Brigham, E. F., & Houston, J. F. (2009).Fundamentals of financial management. Mason, OH: South-Western Cengage Learning. Chan-Lau, J. A. (2005). Hedging foreign exchange risk in Chile: markets and instruments. Washington, DC: IMF. Conrow, E. H. (2003). Effective risk management: Some keys to success. Reston, Va: American Institute of Aeronautics and Astronautics. Penza, P., &Bansal, V. K. (2000). Measuring market risk with value-at-risk. New York [u.a.: John Wiley. Pitblado, R. (1995). Risk assessment in the process industries.Institution of Chemical Engineers. Vose, D. (2008). Risk analysis: A quantitative guide. Chichester, England: Wiley. Read More