What Is Risk Management? Definition

Risk management is the process of analyzing potential risks in a financial venture and taking action to minimize those risks. 

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Risk management occurs constantly throughout the financial world, and strategies vary according to the nature and goals of the parties involved.



What Is the Main Principle of Risk Management?

The main principle in risk management is hedging. In general, this involves investing in one market to minimize the risk incurred by investing in an opposing market. 

In practice, there are many hedging strategies ranging from simple to complex.

Futures contracts, forward exchange contracts, and derivatives are three examples of hedging, in particular, and risk management, in general.

The drawback to these practices is that when risk is minimized, gains are simultaneously limited. 

What Types of Risk Are Being Managed?

The main types of risk in financial risk management are credit and market risk. 

Credit risk is the possibility that a debtor will default on their debts, while market risk involves the potential loss of market position due to changes in that market's prices. 

Liquidity, inflation, and foreign exchange are other financial risks that are constantly being addressed by risk management principles.

 

What Are Three Everyday Examples of Risk Management in Finance?

– A bank requiring high credit scores before they extend a line of credit

– An investor choosing to purchase secure bonds over volatile stocks

– A CFP using standard deviation data to choose good investments for a client



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