Financial Risk Management: An Introduction

Financial Risk Management: An Introduction

Mirela-Madalina Stoian (Technical University of Civil Engineering Bucharest, Romania) and Rares-Gabriel Stoian (Technical University of Civil Engineering Bucharest, Romania)
DOI: 10.4018/978-1-5225-0335-4.ch015
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Abstract

The present paper intends to serve as an introduction into the financial risk management universe. It starts with the basic assumption that performance of an organization is inseparable from the risks it is facing. Any organization should have in place the necessary tools to identify, assess and constantly measure the risks it is exposed to. The paper focuses in defining the basic principles in creating a viable risk management framework that keeps track of three major categories of identified financial risks: market risk, credit risk and liquidity risk. Emphasis is put on the models to measure these types of risks but also on the tools an organization can use in order to reduce them. The second part of the paper is dedicated to recent events that shaped and shocked financial markets and illustrate the consequences faced by organizations when risks are not properly assessed and the risk management models in place are based on dangerously unrealistic notions.
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The Risk Management Framework

In the world of investments, risk is considered to be closely correlated with performance. The risk-return framework is one of the foremost lessons in financial education and it actually explains the fact that you cannot have return without taking any risk. In this context, risk becomes a critical variable to identify, measure and most importantly to manage. As a general rule, organizations should take only the risk they have information about and feel comfortable with. Other risks should be reduced, avoided, or completely hedged (Shimpi, 1999).

In this context, any modern organization should have in place an effective risk management process that is created around five important steps:

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