Defining Risk Management

Risk is generally defined as exposure to uncertainty, such as uncertain environmental variables that cause variation in and unforeseeable outcomes. Risk can also be seen as the probability of loss or unfavorable outcome due to an action, inaction, or external event.

Risk exposure is the level to which the underlying environmental or market risks result in actual risk borne by a business or investor who has assets or liabilities that are sensitive to those risks. Generally speaking, risk exposure is the “vulnerability” to risk resulting from the organization’s or investor’s decisions on risk-sensitive assets and liabilities.

Risks cannot be avoided in a business or investment environment. However, risks taken ought to be cautiously chosen, understood, and well-managed for a chance to make value out of it.

What is Risk Management?

Risk management is the process by which an organization or individual defines the level of risk to be taken, measures the level of risk being taken, and adjusts the latter toward the former, with the goal of maximizing the company’s or portfolio’s value or the individual’s overall satisfaction, or utility.

In other words, risk management includes the decisions and actions that result in an effective way for an investor or an organization to achieve its goals while being exposed to a tolerable level of risk.

It is important to note that risk management does not mean minimizing risk; it is about understanding and taking risks that best suit investment objectives, with a considerable chance of loss, quantifying the exposure, and continuously monitoring and modifying risk.

Moreover, risk management is not about avoiding or predicting risk. Risk management implies that if an unfavaaourable or favorable event occurs, its effect on an organization or a portfolio will not be a surprise and that it should have been quantified and considered beforehand.

Given the dynamic nature of risks and exposures, risk management needs to be continually revised and reevaluated.