Risk Management

How To Avoid Emotional Investing

2011-04-21T08:45:00.001+05:30

Investors have a knack for piling into investments at the top and selling at the bottom. Many investors get caught up in media hype or fear and buy or sell investments at the peaks and valleys of the cycle. Why does this type of emotional investing happen and how can investors avoid both the euphoric and depressive investment traps? Read on for some tips on how to keep an even keel - and keep your investments on track.

Tutorial: Understanding Behavioral Finance

Investor Behavior

The behavior of investors has been well documented; there are numerous theories that attempt to explain the regret and overreaction that buyers and sellers experience when it comes to money and the potential gains and losses on that money. Investors' psyche overpowers rational thinking during times of stress, whether that stress is a result of euphoria or fear.

The typical non-professional investor is putting his hard-earned cash at stake and, while hoping for a gain, wants to protect that cash against losses. Investors get investment "information" from many sources, such as mainstream media, financial news, friends, family and co-workers. Oftentimes investors get enticed by the market during periods of market calm (low volatility) and prolonged bull markets.

Bull markets are periods when the market tends to go up indiscriminately. During such times of market exuberance, investors tend to listen to stories from friends or family members about how much money they are making in the market, creating a stir and compelling those not invested to test the waters. Likewise, when investors read stories about a bad economy or hear reports about a volatile or negative market period, fear takes over and they sell at the bottom. (Not all investors are mentally prepared for when a much-awaited bull market finally comes charging in. To learn more, check out Is Your Psyche Ready For A Bull Market?)

Bad Timing

The lag between when an event occurs and when it is reported is what typically causes investors to lose money. The media will report a bull market only once it has already hit; unless the trend continues, stocks will retract in upcoming periods. Investors, influenced by the reports, often choose these times of premium valuations to build up their portfolios. It is worrisome when the daily stock market report leads off the mainstream news because it creates a buzz and investors make decisions based on "opinions" that are often outdated. Market uncertainty creates fear and brings about an atmosphere of emotional investing.

Time Tested Theory

The theory that many market participants buy at the top and sell at the bottom has proved to be true based on historical money flow analysis. Money flow analysis looks at the net flow of funds for mutual funds. Over a period from 1988 through 2009, money flow analysis showed that when the market hit its peak or valley, money flows were at the highest levels.

Money continued to flow into funds until the market hit bottom, and only then did investors start to pull money out of the market and money flows turned negative. The net outflows peaked at market bottoms and continued to be negative even as the market moved into an upward trend. Because the market was shown to fall before funds were sold, and funds were often reinvested after the market had alreayd moved up, it's clear htat investors often fail to time their trades in the most beneficial manner.

A Bright Spot

Despite the strong tendencies that investors portray at the peaks and valleys, they have gotten other periods correct. Throughout the 1990s, there was a steady flow of funds into the market during a period when the market was on a prolonged bull run. Likewise from 2004 to 2007, during another strong bull market, investors poured money into the market. So it can be hypothesized that during periods of very little volatility (such as prolonged bull markets), investors become more comfortable in the market and begin to invest. However, during periods of volatility, or when bull or bear markets begin and end regularly, money flows tend to reflect confusion and the timing of the flows becomes mismatched with actual market movement. (Discover how some strange human tendencies can play out in the market. Are we really rational? Check out Understanding Investor Behavior.)

Strategies to Take the Emotion Out of Investing

A 2009 study of investment behavior by DALBAR showed that over the 20-year period from January 1989 to December 2008, the S&P 500 returned an average annual 8.4% by by Kristina Zucchi
how-to-avoid-emotional-investing.asp_ (investopedia.com)

but the average stock investor returned only 1.9% annually. The evidence suggests that emotional investing gets the best of the typical investor during periods of uncertainty. There are strategies, however, that can alleviate the guess-work and reduce the effect of poorly timing fund flows.

The most effective tends to be the dollar-cost averaging of investment dollars. Dollar cost averaging is a strategy where equal amounts of dollars are invested at a regular, predetermined interval. This strategy is good during all market conditions. During a downward trend, investors are purchasing shares at cheaper and cheaper prices. During an upward trend, the shares previously held in the portfolio are producing capital gains and fewer shares are being added at the higher price. The key to this strategy is to stay the course- set the strategy and don't tamper with it unless a major change warrants revisiting and rebalancing the established course. (There is more than one way to work this strategy. Find out more in Choosing Between Dollar-Cost And Value Averaging.)

Another technique to diminish the emotional response to market investing is to diversify a portfolio. There have been only a handful of times in history when all markets have moved in unison and diversification provided little protection. In most normal market cycles, the use of a diversification strategy provides downward protection. Diversifying a portfolio can take many forms - investing in different industries, different geographies, different types of investments and even hedging with alternative investments like real estate and private equity. There are distinctive market conditions that favor each of these subsectors of the market, so a portfolio made up of all these various types of investments should provide protection in a range of market conditions.

Conclusion

Investing without emotion is easier said than done, especially because uncertainty rules the market and the media. Evidence suggests that most investors are emotional and maximize money flows at the wrong times - a surefire way to reduce potential returns. Strategies that eliminate the emotional response to investing should produce returns that are significantly greater than those indicated by the typical investor responding to the market rather than proactively investing in the market. Dollar-cost averaging and diversification are two proven strategies within a multitude of other alternatives to reduce an investors emotional reaction to the market. (Curious about how emotions and biases affect the market? Find some useful insight in Taking A Chance On Behavioral Finance.)

Identifying Share Market Risks

2010-09-16T12:03:00.000+05:30

In today's financial realm, there are plenty of avenues of education for potential investors who want to know what the rewards and the risks of the share market are before they get deeply committed with their capital. It makes perfect sense to have some way to count the costs associated with the various investment opportunities that are available in the trading of listed securities.

Naturally, the benefits are fairly obvious: you can gain significant returns on your initial investment as the prices of shares rise and you can earn dividends as well. If the market runs in your favor and you make wise decisions, you should have no trouble making a profit. The bigger question that should be answered with more detail is this: What are the risks involved with investing in the share market?
Risks are recognized on various levels from general market risk to very specialized categories of risk such as those related to the particular industry in which the business you've invested in is a part of as well as matters of market timing. There are basically at least six distinctive types of share market risks that are readily identifiable.

As started previously, there is the reality of total or overall market risk. This is the broadest type of risk that has far-reaching effects upon the entire stock and securities market. The causes for this type of risk include political, economic, interest rate changes, etc. These exterior events of changes directly affect the flow of the share market. Similarly, but on a larger international scale, you can have what is called global risk. This is basically the risks to share prices that arise from international events or market factors. Global risk factors include changes to trade and tariff policies or exchange rates.

More specific or targeted types of risk have to do with either the particular sector or industry that your investments fall into or even an individual equity investment's performance. The former has to do with the products or services of a company and their current demand in the consumer market as well as issues like commodity prices. The latter risks may be associated with internal practices or performance of the business you have purchased shares from; the stability of the company's infrastructure, liquidity of the investment, etc.

Timing is everything or so it is said, but in the share market having bad timing can mean a bad financial loss if you do not take it into account as a risk. The best way to avoid losing your capital is to pace your investing and buy stocks little by little. There is a final type risk that has to do with certain types of investments that known as a speculative investments. These are also a matter of timing since the idea behind this type of investment is that the price could rise or fall dramatically at any time. If you want to profit from speculative investments you will have to take big risks.
The share market is a delicate balance between all of these risks and the real potential for success.

Financial Crisis Year 2008

2009-11-23T09:21:00.003+05:30

The global financial crisis has spread rapidly since the fall of 2008, leading to a global downturn of uncertain severity and duration. The impact of financial sector turmoil on real activity has become increasingly evident, propagating beyond its initial epicenters to affect other advanced economies, emerging markets, and LICs. This paper analyzes the impact of the global financial crisis on LICs.
1
It provides an overview of the possible impact of the crisis on the short-term macroeconomic outlook. To assess the magnitude of the effects, the paper compares current (January 2009) projections with those made before the crisis. In addition, simulations illustrate the heavy downside risks to these projections.While for many LICs the effects of the crisis have lagged the rest of the world, its eventual impact may be severe, especially given their often limited scope for countercyclical policies. Many LICs have made great strides in strengthening their policy frameworks and robustness to shocks, reducing poverty, and reforming their financial systems. But many remain highly vulnerable to a deep global downturn that so closely follows the 2007/08 food and fuel price shocks. Financial market linkages are generally weak, but second-round effects of the economic slowdown on the financial system could be particularly severe. Without additional aid, the scope for countercyclical policies is limited for most LICs due to binding financing constraints and fragile debt positions. This could both deepen and prolong the crisis in LICs, and set back the fight against poverty. Against this background, the paper provides policy advice on how best to address the impact of the crisis on LICs and describes the Fund support.The Fund assists countries in designing policies to support growth and mitigate risks to the financial system. The Fund is also deploying its own financing facilities for LICs, while making efforts to sustain and catalyze additional assistance from other institutions and donors.The paper is structured as follows. Section II discusses the outlook for global economic growth and commodity prices, while Section III provides an overview of the changes in economic projections associated with the crisis. The various financial channels and spillovers from the global downturn are discussed in Section IV. Section V analyzes the fiscal and debt sustainability implications of the crisis. Country vulnerabilities are investigated in Section VI. Policy recommendations to help countries weather the crisis are considered in Section VII, with LICs’ potential additional financing needs assessed in Section VIII. Finally, Section IX concludes with a review of ways in which the Fund can assist its LIC membership.
1
Generally, references to LICs in Fund documents relate to all 78 PRGF-eligible countries. However, because of data limitations, and unless indicated otherwise, data for LICs reported in this paper refer to the more limited set of 71 countries listed in Appendix I.

Risk in banking sector

2009-06-26T11:16:00.003+05:30

Risks Associated with Lending

According to the OCC’s supervision by risk philosophy, risk is the potential
that events, expected or unexpected, may have an adverse impact on the
Loan Portfolio Management 4 Comptroller’s Handbook

bank’s earnings or capital. The OCC has defined nine categories of risk for
bank supervision purposes. These risks, which are defined in other
Comptroller’s Handbook sections, are credit, interest rate, liquidity, price,
foreign exchange, transaction, compliance, strategic, and reputation. Banks
with international operations are also subject to country risk and transfer risk.
These risks are not mutually exclusive; any product or service may expose the
bank to multiple risks. For analysis and discussion, however, the OCC
identifies and assesses the risks separately.

A key challenge in managing risk is understanding the interrelationships of
the nine risk factors. Often, risks will be either positively or negatively
correlated to one another. Actions or events will affect correlated risks
similarly. For example, reducing the level of problem assets should reduce
not only credit risk but also liquidity and reputation risk. When two risks are
negatively correlated, reducing one type of risk may increase the other. For
example, a bank may reduce overall credit risk by expanding its holdings of
one- to four-family residential mortgages instead of commercial loans, only to
see its interest rate risk soar because of the interest rate sensitivity and
optionality of the mortgages.

Lending can expose a bank’s earnings and capital to all of the risks.
Therefore, it is important that the examiner assigned LPM understands all the
risks embedded in the loan portfolio and their potential impact on the
institution. How each of these categories relates to a bank’s lending function
is detailed in the following sections.

Credit Risk

For most banks, loans are the largest and most obvious source of credit risk.
However, there are other pockets of credit risk both on and off the balance
sheet, such as the investment portfolio, overdrafts, and letters of credit. Many
products, activities, and services, such as derivatives, foreign exchange, and
cash management services, also expose a bank to credit risk.
The risk of repayment, i.e., the possibility that an obligor will fail to perform
as agreed, is either lessened or increased by a bank’s credit risk management
practices. A bank’s first defense against excessive credit risk is the initial
credit-granting process S sound underwriting standards, an efficient, balanced approval process, and a competent lending staff. Because a bank cannot
easily overcome borrowers with questionable capacity or character, these
factors exert a strong influence on credit quality. Borrowers whose financial
performance is poor or marginal, or whose repayment ability is dependent
upon unproven projections can quickly become impaired by personal or
external economic stress. Management of credit risk, however, must
continue after a loan has been made, for sound initial credit decisions can be
undermined by improper loan structuring or inadequate monitoring.

Traditionally, banks have focused on oversight of individual loans in
managing their overall credit risk. While this focus is important, banks
should also view credit risk management in terms of portfolio segments and
the entire portfolio. The focus on managing individual credit risk did not
avert the credit crises of the 1980s. However, had the portfolio approach to
risk management augmented these traditional risk management practices,
banks might have at least reduced their losses.

Effective management of the loan portfolio’s credit risk requires that the board
and management understand and control the bank’s risk profile and its credit
culture. To accomplish this, they must have a thorough knowledge of the
portfolio’s composition and its inherent risks. They must understand the
portfolio’s product mix, industry and geographic concentrations, average risk
ratings, and other aggregate characteristics. They must be sure that the
policies, processes, and practices implemented to control the risks of
individual loans and portfolio segments are sound and that lending personnel
adhere to them.

Banks engaged in international lending face country risks that domestic
lenders do not. Country risk encompasses all of the uncertainties arising from
a nation’s economic, social, and political conditions that may affect the
payment of foreigners’ debt and equity investments. Country risk includes
the possibility of political and social upheaval, nationalization and
expropriation of assets, governmental repudiation of external indebtedness,
exchange controls, and currency devaluation or depreciation. Unless a
nation repudiates its external debt, these developments might not make a
loan uncollectible. However, even a delay in collection could weaken the
lending bank.
Transfer risk, which is a narrower form of country risk, is the possibility that
an obligor will not be able to pay because the currency of payment is
unavailable. This unavailability may be a matter of government policy. For
example, although an individual borrower may be very successful and have
sufficient local currency cash flow to pay its foreign (e.g., U.S. dollar) debt,
the borrower’s country may not have sufficient U.S. dollars available to
permit repayment of the foreign indebtedness. The transfer risk associated
with banks’ exposures in foreign countries is evaluated by the Interagency
Country Exposure Review Committee (ICERC). For examination purposes,
the transfer risk rating assigned to a country by the ICERC applies to all bank
assets in that country. However, examiners may classify individual loans and
other assets more severely for credit risk reasons.
Strategies for managing country risk will be discussed in “Country Risk
Management,” a separate booklet in the Comptroller’s Handbook.

Disaster Planning and Recovery

2009-06-05T09:29:00.001+05:30

Disaster Planning and Recovery

Resources to help you keep disasters from becoming disastrous

In the wake of a disaster — whether typical disk failure or catastrophic flood — it can be difficult to know where to begin the recovery process. With so many other pressing concerns, how should you prioritize IT recovery? What steps need to be taken immediately, and which can wait?

In this toolkit, you'll find resources to help you plan ahead so that you can limit the damage from a disaster; a comprehensive, downloadable guide to recovery; and information about tools to help keep your nonprofit's data safe should the unthinkable happen.

We have setup the toolkit into three sections — Plan, Mitigate, and Recover — so you can take a step-by-step approach to disaster planning and recovery.

Plan Your Response Early

In the planning phase, your organization should focus on documenting critical information necessary for recovery and developing procedures to help ensure an efficient and thorough recovery.

Backing Up Your Data
Regular backups are vital insurance against a data-loss catastrophe, yet many organizations learn this lesson the hard way. We'll show you tools and strategies for safeguarding your nonprofit's hard-to-replace information.

Keep Your Data Safe with Online Backup Services
Online backup services automate the uploading of selected files to a remote computer and offer the ability to restore files using your Internet connection. Find out what to consider when choosing a provider.

The No-Excuses Guide to Automated Online Backup
Still not sure about online backups? We'll walk you through the setup for EVault Small Business Edition to help you get a sense of how such a process works and provide additional tips for choosing provider.

Technology Planning for Civil Emergencies
Depending on the type of disaster and the availability of resources, your organization may find itself acting as a de facto emergency service assisting victims with first aid, transport, or counseling. Here, we show you ways to prepare your organization to deal with the unthinkable.

Virtual Community Topic: Do You Use an Automated Online Backup Service?
Find out which backup services other nonprofits recommend and ask your own questions.

Hardware Topic: How Long Do Backup Tapes Last?
TechSoup forum experts answer one reader's question about the durability of tapes and offer strategies to keep them running.

Principles of risk management

2009-05-17T14:47:00.000+05:30

The International Organization for Standardization identifies the following principles of risk management: ^[4]

Risk management should create value.
Risk management should be an integral part of organizational processes.
Risk management should be part of decision making.
Risk management should explicitly address uncertainty.
Risk management should be systematic and structured.
Risk management should be based on the best available information.
Risk management should be tailored.
Risk management should take into account human factors.
Risk management should be transparent and inclusive.
Risk management should be dynamic, iterative and responsive to change.
Risk management should be capable of continual improvement and enhancement.

Introduction

2009-05-17T14:45:00.000+05:30

This section provides an introduction to the principles of risk management. The vocabulary of risk management is defined in ISO Guide 73, "Risk management. Vocabulary" ^[2].

In ideal risk management, a prioritization process is followed whereby the risks with the greatest loss and the greatest probability of occurring are handled first, and risks with lower probability of occurrence and lower loss are handled in descending order. In practice the process can be very difficult, and balancing between risks with a high probability of occurrence but lower loss versus a risk with high loss but lower probability of occurrence can often be mishandled.

Intangible risk management identifies a new type of a risk that has a 100% probability of occurring but is ignored by the organization due to a lack of identification ability. For example, when deficient knowledge is applied to a situation, a knowledge risk materialises. Relationship risk appears when ineffective collaboration occurs. Process-engagement risk may be an issue when ineffective operational procedures are applied. These risks directly reduce the productivity of knowledge workers, decrease cost effectiveness, profitability, service, quality, reputation, brand value, and earnings quality. Intangible risk management allows risk management to create immediate value from the identification and reduction of risks that reduce productivity.

Risk management also faces difficulties allocating resources. This is the idea of opportunity cost. Resources spent on risk management could have been spent on more profitable activities. Again, ideal risk management minimizes spending while maximizing the reduction of the negative effects of risks.