Financial Terms / risk

# Assessing Risk

Risk is an important factor to consider when making decisions, as it is quantified by analyzing past behavior and results.

## Formula

``Risk = Probability of Loss x Potential Loss``

## How do I calculate the risk?

`In order to calculate risk, it is recommended to use the Monte Carlo simulation, a method of obtaining results when modeling a problem mathematically. This method uses algorithms that can be run on any computer capable of generating a large number of random numbers from a chosen distribution. The Monte Carlo simulation generates N random numbers for each element and executes mathematical calculations on these elements, making it easier for experts to provide quantitative inputs. The formula for calculating risk is: `Risk = Probability of Loss x Potential Loss.` This calculation can be done on programs such as Sourcetable.`

## What is Risk?

`Risk is uncertainty about investments. It can negatively impact financial welfare and comes from investments, market conditions, corporate decisions, events in a country, liquidity, and how many investments are held.`

## What is Hedging?

`Hedging involves short selling and can add to costs. Speculative hedging adds to costs and can also add to risk.`

## Key Points

How do I calculate risk?
`Risk = Probability of Loss x Potential Loss`
Algorithmic Hedging
Risk modeling includes algorithmic hedging which is a type of automated trading that uses mathematical models to make decisions about trading. Algorithmic hedging is used to manage risk in a portfolio by monitoring the portfolio's market exposure and making changes when needed.
What is Tail Risk?
Tail risk refers to the risk of an extreme event that would have a significant impact on the value of a portfolio or a market. These events are considered rare but can have devastating effects when they occur.
What is Systemic Risk?
Systemic risk is the risk that a disruption at a firm, in a market segment, to a market maker, or in a market could cause severe instability or collapse in the entire financial system. It's often associated with a 'domino effect' where the failure of one entity leads to distress or failures of others.
What is Reinvestment Risk?
Reinvestment risk is the risk that future cash flows – either interest or principal – will have to be reinvested at a lower potential interest rate. This is particularly relevant for bond investors, especially when interest rates are falling.
What is Model Risk?
Model risk is the risk of loss resulting from using insufficiently accurate models to make decisions. This can occur due to errors in the model's design, incorrect or incomplete data, or inappropriate use of the model.
What is Sequence of Returns Risk?
Sequence of returns risk refers to the risk of receiving lower or negative returns early in a period when withdrawals are made from an individual's underlying investments. This is especially relevant for retirees who are drawing down their portfolios.