Introduction to Risk

What is Risk ?

Picture source: pm-primer.com

In general terms risk is the variability of adverse outcomes that are unexpected and, in finance it is volatility of unexpected losses. Risk can be divided into Basic risk, Capital risk, Country risk, Default risk, Delivery risk, Economic risk, Exchange rate risk, Interest rate risk, Liquidity risk, Operations risk, Payment system risk, Political risk, Refinancing risk, Reinvestment risk, Settlement risk, Sovereign risk, and Underwriting risk. It is a probability or threat of damage, injury, liability, loss, or any other negative occurrence that is caused by external or internal vulnerabilities. The key point to be noted from above definition is that risk is not expected loss rather it is a potential for unexpected loss. Additionally it is important to note that risk is neither peril or hazard, because peril is the cause of a loss, and hazard is a condition that increases the probability of unexpected loss or adverse outcome.

Risk is not 'the size of a cost or of a loss'

There are some relatively large cost that we expect in our daily life; e.g Auto Loan, House Loan, University fees etc. Although they are large they are not threat to our ambitions or aspirations, this is because they are all predicted and are already accommodated in our plans. However there is a risk that these costs will scale up and rise unexpectedly, or there might be chances that other costs appears from nowhere and restricts our capacity. So it is right to say that the risk lies in how variable our costs and revenues/losses are,  but it is not appropriate to categorize cost and losses as risk.