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Risk Assessment

Generally, risk assessment implies finding out the possibility of a loss on an asset, a loan, or an investment. Assessment of risk is important to understand how worthwhile investment is and the steps required to mitigate the risk involved.

It is also vital for an investor so as to determine their rate of return to consider an investment worth the potential risk and in the following analysis, we seek to simplify the risk assessment meaning.

What is risk assessment?

Undoubtedly, risk assessment helps Governments, Corporations, or Investors to assess the chances of an adverse event that might hamper an investment, business, or economy.
Risk analysis not only offers the investors a variety of different approaches but also help them to determine the risk in an investment opportunity.

Generally, an investor can use two types of risk analysis techniques,

i) Quantitative analysis and

ii) Qualitative analysis.


Risk Analysis for Investors – Quantitative and Qualitative

The following terms are important parts of the risk assessment steps:

Qualitative risk analysis is subjective in nature. It identifies the risks and thereby finds the possibility of a negative event to occur during the cycle of a project and the impact it will have on its schedule. The risk assessment matrix records the risk.

Quantitative risk analysis is objective in nature. It utilizes data to study the effects of risk in regards to cost overruns, resource consumption, and schedule delays. In general terms, it means that, for example, risk A has a 30% chance of taking place and a 10% chance of causing a delay based on the quantifiable data.


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Types of Risk Involved In Investing

Liquidity risk: The risk of not being able to sell off your investment at a decent price and get your money when you want. Thus, forcing you to sell your investment at a much lower price, i.e. at a loss.

Market risk: The risk of an investment losing its value because of the economic situation and events that impact the markets. They are of 3 types, equity risk, interest rate risk, and currency risk.

Credit risk: This is a risk that a government entity or a company will run into financial problems and won’t be able to pay the interest or repay the principal at maturity.

Reinvestment risk: The risk also arising from reinvesting the principal or income at a lower interest rate.

Inflation risk: The risk of a loss in purchasing power as the value of your investments falls behind inflation.


Types of risk involved in your portfolio

Investments risks are also involved at the portfolio level and individual security level. The following risks are specific to individual securities and can be managed through diversification,

  • Default risk
  • Liquidity risk
  • Regulatory risk and political risk, etc.

While there are broader risks like Market risk, Interest rate risk, reinvestment risk, and Currency risk which require a deeper analysis. The procedure mandates to go through each risks associated with a portfolio and devise steps to mitigate them.

Risk Assessment methods

There are many ways to measure portfolio risk. They have their advantages and shortcomings. All of them are used in combination to determine the risk. They also serve as tools necessary for the mitigation of the risks.


Standard Deviation:

It measures the variation that will be there between the return on investment and its average returns.

The formula for Standard Deviation is,

Risk Assessment

ri = actual rate of return
rave = average rate of return
n = number of time periods


Sharpe Ratio:

It is named after American Economist, William Sharpe and is used to measure the performance of an investment after adjustment of its risks. The higher the ratio will be, the more investment return relative to the amount of risk taken, and so, the better the investment.

risk assessment



It suggests how risky individual security is relative to the market. The overall beta for the whole market is 1. Beta 1 stocks move up and down like the rest of the market.

risk assessment


        Covariance = measure of a stock’s return relative to that of the mark

        Variance = Measure of how the market moves relative to its mean​


VaR or Value at Risk:

VaR is the maximum loss a portfolio is expected to be impacted within a given period of time and confidence. Banks and regulators use it to quantify risks.

Risk Assessment


CVaR or Conditional Value at Risk:

It is a risk assessment that quantifies the amount of tail risk an investment portfolio has.

Risk Assessment


p(x)dx= probability density of getting a return with value “x”

c=the cutoff point on the distribution where the analyst sets the VaR breakpoint

VaR=the agreed-upon VaR level

Our closing thought on Risk Assessment:

The definition clarifies the importance of understanding and managing the risks within a portfolio. Quantifying the risks within a portfolio will allow the investors to optimize their returns. Asset allocation decisions become the most vital aspect which will determine the risks a portfolio will face. Risky assets can be allocated maximum capital and maximum returns ensured if more number of risks can be quantified and managed. Standard Deviation, Beta, Sharpe ratio, VaR, and CVaR can be used to find out the risk involved in a portfolio, which are also a part of the process of assessing risk. This helps in quantifying the overall risk and make considered choices vis a vis asset allocation.

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