Foundations of Risk Management

Risk is the variability of future outcomes around an expected value, i.e., exposure to uncertainty whose realizations can be either better or worse than expected.

Pure risk has only the possibility of loss or no loss (e.g., fire), while speculative risk carries the possibility of either gain or loss (e.g., trading positions).

Investors and firms must accept greater risk to earn higher expected returns; bearing risk is only rational if compensated by a sufficient expected return (risk premium).

The additional expected return demanded by investors for bearing risk, above the risk-free rate; it compensates for the uncertainty of outcomes.

The risk of losses from movements in market prices or rates: equity prices, interest rates, exchange rates, and commodity prices.

Interest-rate risk, equity price risk, foreign-exchange (currency) risk, and commodity price risk.