But no one really could predict the lockdowns or the supply-chain crisis. That is, we might have expected - and made allowances for - economic downturns despite not knowing where interest rates will be or how economies would grow or contract (i.e., known unknowns). The best kind of FRM will consider the fourth classification, unknown unknowns, or the events you haven’t even imagined yet.Īrguably, the COVID-19 pandemic was an unanticipated unknown for most businesses. Risk management is also about controlling exposure to “unknown unknowns.” To illustrate, we can classify future outcomes into the following four categories. Risk managers not only understand the mathematics behind these measures, but they also know how to pick the most appropriate one. Hence, standard deviation is the favored metric there. In contrast, for capital budgeting decisions, practitioners prefer a measure of the dispersion of potential outcomes. So, R-Squared is their preferred measure. Others highlight how risk is the tendency for, say, an investment to be different from a benchmark. Some say that, by definition, risks are immeasurable, so any metric is futile. However, there are debates on the proper depiction of risk. In the realm of Finance, “risk” is the possibility that an outcome turns out to be different than what was expected. As such, FRM is focused on financial risks of various kinds: market risks, credit risks, liquidity risks, and operational risks. So, why do risks impact financial decisions? What challenges do FRM specialists face? And what skills do you need to possess to join their exclusive ranks? What is Financial Risk Management (FRM)?Īt its core, risk management is about controlling the risks an entity brings upon itself. This is truer than ever when we talk about the world of Financial Risk Management (FRM). But risks should be an integral part of decision-making, as they can easily sway seemingly excellent endeavors into catastrophic ones. In other words, we often evaluate whether a project is good or bad based on its expected outcome. Human impulse tends to focus on what we get in return for our actions.
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