[Risk Management Series 1] Why we have to know about the risk management?
2009/09/27 4 Comments
A global recession hit the world and the many countries are trying to escape from the recession. The problem is HOW. Traditionally, governments make a decision in changing interest rate and make policies to help companies in their country. Though the financial policies can be after-solution for the companies, but it cannot be before-solution for them. Many financial experts says the risk management can be a solution for them, but does it really helpful for the companies?
What is the risk management? Risk management means managing the risk, as it stands. The risk is defined as the identification, assessment, and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events (cited from Wikipedia.com). Some economists says that the beginning of the global recession is triggered by the failure of state-of-art financial product from global financial institutes.
The state-of-art financial product is very similar to a gambling. I will show you a very simple example with a coin tossing. In a coin tossing, you have to pay $1 to get a right to toss a coin. If the coin shows the front side of it after tossing then you will get $2, but in case of the back side then you have to pay additional $1. This is the basic structure of a coin tossing.
Now, I will use the interest rate of mortgage loan than a coin tossing. If the interest rates fluctuate less than 10% then you will get $1,000,000, and you will lose $1,000,000 if it fluctuate more than 10%. Just imagine that you are the player of this game. In your experience, you do know that the interest rate of mortgage loan never fluctuate more than 7% since the last 30 years, so you might think that you want to join this game. But after you joined the game, there was an unexpected event was happened and the interest rate fluctuated more than 15%. As you know, you have to pay $1,000,000. This is not exactly same what happened in real world, but a quite similar example happened in our world.
This is why many people says risk management has to be done. If you knew the future interest then you might not participated in the game. Predicting the future is very difficult as you already know, but we can prepare for the future by using historical data and measuring current status. As you can see from the gambling example, historical data cannot fully protect you from the future events. But still historical data can help you in risk management and this is also used in many companies.
In the next series, I will show you the risk management in our world and why government level risk management is crucial in modern society.