Financial risk is the prospect of financial loss or gain which is caused by unpredicted changes in the risk factors. Market risks arise from unseen or unpredictable prices in the market prices and market rates. These risks can be classified into, interest rate risks, exchange rate risks' and others depending on the category of the risk factors. Market risks can be calculated using the probability distribution change of value in the market over a given time span.
Risks need to be assessed. There are different methods of assessing risks. These methods use statistics to determine and calculate risk and uncertainties probabilities which are used to classify the levels of these risk. Statistical approaches are used in determining the probability of risk occurrence to check the number assigned to them by their constructors and the constants (Aven, 2016). These methods mostly make use of the quantitative approach. In other words, individuals use statistical data methods to determine and identify factors which are contributing to high risks. This is done to ensure that an organization will employ an informed decision process when developing a risk arresting and mitigation plan.
Various tools can be applied to measure risks. One of these tools is the standard deviation. Standard deviation is the method used to measure risks. It measures the average variation an individual data differs from the given mean. Standard deviation is used to indicate market volatility (Albright et al. 2011). Market volatility illustrates the risk. In this case, the wider the range between the predictable price and the mean, the greater the risk involved.
Standard deviation is used by investors to measure stock portfolio which is generally how the stock returns vary from the average returns of the stock. When using standard deviation for risk measurement in the stock market, some assumptions are made, one of the assumption being that the prices follow the pattern of the normal distribution.
The other statistical tool or method used to measure risks is the coefficient of variation. This is a method that and allows one to determine the risk they are assuming compared to the amount of return expected from their investment. It is the ratio of the standard deviation to mean return. It is used in finance to measure the amount of risk per given unit of the mean return. This method is useful when one wants to gauge the risk in the form of degree of data dispersion (Bossaerts, 2006). The coefficient of variation tends to be a better way of measuring risks. This is because the distribution of an asset return can be quantified about the expected returns. Thus, giving a good comparison of different components of investment. A low Coefficient of variation indicates that there are low risks while a high Coefficient of variation indicates that there are high risks. It is therefore recommended for companies intending to have different investments and a broad range of assets. The method will help such companies to reduce the risks of the major fluctuation contained in a single investment. Making the risk and diversification to be inversely proportional, that is, as the investment diversification is increasing, the risk reduces.
Poor loss ratios have hindered premium acceptance. The best statistical tool that the company can consider implementing to measure market risks is the coefficient of variation. Given that the company is performing well following several performance indicators, there should consider using the Coefficient of variation to enable them to compare the different investment within their institution (Nobes & Stadler, 2015). By employing Coefficient of variation in market risk measurement, the board will have a better picture regarding the investments. They will make informed decisions based on the statistical data obtained. Decision making process is very essential when it comes to the process of managing risks. It is the decisions that are made which determine whether an organization will be able to achieve at its full potential growth or not. This will ensure that the poor loss ratio issue is solved. It is recommended since it helps companies to reduce the risks of the main fluctuation contained in a single investment and diversify these risk to different investment giving a clear prediction.
There are some consequences that Premium Acceptance may face if they decide of not using statistical methods, one being the poor accuracy of the results they are likely to get from other methods of measuring market risks. Statistical results are supported by evidence. Inappropriate data and results mean that the business is likely to make uninformed decisions which may see them making losses due to poor choices of investment decision.
In conclusion, it is advisable for any financial institution to conduct market risks assessment before making an investment. This will ensure that the business invests in the most relevant fields since decisions made will be guided by the information obtained, reducing the probability of the company making losses. Also, risks which are taken by any firm should be calculated risks meaning that they should not be reckless. This is why the market risk assessment is very essential.
Aven, T. (2016). Risk assessment and risk management: Review of recent advances on their foundation. European Journal of Operational Research, 253(1), 1-13.
Bossaerts, P. (2006). Lectures on corporate finance. World Scientific Publishing Co Inc.
Albright, S., Winston, W. & Zappe, C. (2011). Data analysis and decision making. Mason, Ohio: South-Western/Cengage Learning.
Nobes, C. W., & Stadler, C. (2015). The qualitative characteristics of financial information, and managers accounting decisions: evidence from IFRS policy changes. Accounting and Business Research, 45(5), 572-601.
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