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Introduction to Risk

  • Risk can be broadly defined as the degree of uncertainty about future net returns:
    • Credit risk relates to the potential loss due to the inability of a counterpart to meet its obligation
    • Operational risk takes into account the errors that can be made in instructing payments or settling transactions
    • Liquidity risk is caused by an unexpected large and stressful negative cash flow over a short period
    • Market risk estimates the uncertainty of future earnings, due to the changes in market conditions
  • Broadly the standard deviation of the variable measures the degree of risk inherent in the variable
  • Say the standard deviation of returns from the assets owned by you is 50% and the standard deviation of returns from assets I own is 0%. We can say that risk of my assets is zero


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