instruction
stringlengths 5
1.05k
| output
stringlengths 6
22.3k
| input
stringclasses 1
value |
|---|---|---|
how a revocable trust works | a revocable trust is a part of estate planning that manages the assets of the grantor as the owner ages the trust can be amended or revoked as the grantor desires and the property it holds is included in estate taxes depending on the trust s directions a trustee might be assigned to manage the assets or property within the trust the trustee is also charged with distributing the assets to the beneficiaries the trust remains private and becomes irrevocable upon the grantor s death the money or property held by the trustee for the benefit of someone else is called the principal of the trust the value of the principal can change due to the trustee s expenses or the investment s appreciation or depreciation in the financial markets the collective assets comprise the trust fund the person or people benefiting from the trust are the beneficiaries because a revocable trust holds the assets and it doesn t die the trust avoids probate which is the legal process of distributing assets of a will the grantor often acts as the trustee of a revocable trust this is quite unlike an irrevocable trust these trusts have been the centerpieces of most estate plans for decades all trusts are either revocable i e living trusts that can be changed by the grantor if need be or irrevocable fixed trusts that cannot be changed once established advantages and disadvantages of a revocable trustthere are several advantages of establishing a revocable trust if the grantor experiences health concerns through the aging process a revocable trust allows the grantor s chosen manager to take control of the principal if the grantor owns real estate outside the state of the grantor s domicile and the real estate is included in the trust the ancillary probate of the real estate is avoided if a beneficiary is not of legal age and cannot hold property the minor s assets are held in the trust rather than having the court appoint a guardian if the grantor believes a beneficiary will not use the assets wisely the trust allows a set amount of money to be distributed on a regular basis administration of these trusts is quite easy they re disregarded entities for income tax purposes meaning that any assets in the trust carry through to their grantors during their lifetimes there are some disadvantages to revocable trusts implementing a revocable trust involves much time and effort assets must be retitled in the name of the trust to avoid probate the grantor s entire estate plan must be monitored annually to ensure the trust s objectives are being met costs of maintaining a revocable trust are greater than other estate planning tools such as a will a revocable trust does not offer the grantor tax advantages it s possible that not all assets will be included in the revocable trust so the grantor must create a will to designate beneficiaries for the remaining assets to avoid probate during the grantor s lifetime creditors can still reach the property in a revocable trust flexible and revocablecan avoid probateprotection of trustor becomes incapacitatedestablishes privacy for assetsno immediate tax advantagesno creditor protectioncan be expensive to establish and administer | |
what is a revocable living trust | a living trust is one established during one s lifetime and can be either revocable or irrevocable a revocable living trust is often used in estate planning to avoid probate court and fights over the assets of an estate unlike an irrevocable trust the revocable living trust does not confer tax or creditor protection | |
which is better a revocable or irrevocable trust | revocable and irrevocable trusts are intended to be used for different purposes and therefore each is best suited for those purposes revocable trusts are best for estate planning in conjunction with a will where the assets remain under the control of the trustor an irrevocable trust cannot be changed or altered once established and the trust itself becomes a legal entity that owns the assets put inside of it because the trustor no longer controls those assets there are certain tax advantages and creditor protections these are best used for transferring high value assets that could cause gift or estate tax issues in the future | |
when the grantor trustor of a revocable trust dies the trust automatically converts into an irrevocable trust | can you get deposit insurance on a trust account yes you can as of april 1 2024 the federal deposit insurance corporation fdic has issued final regulations that alter how bank accounts held in the name of a trust will be insured the regulations effectively treat revocable and irrevocable trusts the same in terms of determining the limits on insurance combining them into a single category called trust accounts that means that funds in a bank for a trust are insured up to 250 000 per beneficiary per fdic insured bank up to a maximum of five eligible beneficiaries or 1 25 million an eligible beneficiary can be any living person or a charity or nonprofit recognized by the irs for example a trust owner with three eligible primary not contingent beneficiaries is insured up to 750 000 1the bottom linea revocable trust which you create during your lifetime can help you manage your assets as well as protect you if you become ill or disabled its advantage over an irrevocable trust is that you can usually revoke or amend it whenever you might want to also a revocable trust will help your heirs avoid probate but it won t help them avoid estate tax | |
what is a revolver | a revolver refers to a borrower either an individual or a company who carries a balance from month to month via a revolving credit line borrowers are only obligated to make minimum monthly payments which go toward paying interest and reducing principal debt revolvers are used by corporations to fund working capital needs which are expenses for day to day operations such as payroll a revolver can sometimes be referred to as a revolver loan or revolving debt however revolver loans are usually fixed rate credit products and are synonymous with business loans a revolving credit line typically comes with a variable interest rate set by a bank meaning it can fluctuate with market conditions understanding revolversthe term revolver comes from revolving credit a category of financing or borrowing a revolver lets an individual consumer or a business open a line of credit through a credit card or line of credit bank account where the credit issuer offers a specified level of credit over time credit issuers tend to profit handsomely from revolvers because the open ended credit line means companies can use them frequently and keep them in use for extended periods of time a credit card is the most common form of revolving credit revolving debt versus non revolving debtrevolving and non revolving credit lines each have distinct advantages revolving financing allows the borrower to maintain an open credit line up to a specified limit non revolving financing involves a loan whereby a one time payout is issued to the borrower who must in turn make fixed payments according to a schedule revolver financing doesn t involve fixed payments or coupon payments instead a minimum monthly payment is due based on the balance and interest rate according to the terms of the credit agreement the total amount of outstanding revolving debt in the united states as of aug 2023 according the federal reserve 1non revolving credit loans are often obtained both by businesses seeking capital with which to finance new projects and by consumers looking to buy homes cars and other big ticket items while the underwriting approval standards are typically the same for both revolving and non revolving credit revolving credit lines usually involve a more simplified application process the emergence of fintech technologies has dramatically increased the availability of both revolving and non revolving credit products providing greater access to credit to underbanked populations consumers in the market for non revolving loans may now choose from independent lenders such as lending club or prosper special considerations revolving credit paymentsconsumers and small businesses are often drawn to revolving credit due to low introductory rate offers and reward benefits furthermore when borrowers make a payment it reduces their outstanding debt balance and makes more money available for future borrowing a borrower approved for a revolving credit line can keep the credit line open for an undefined period of time so long as they remain in good standing with the credit issuer | |
does a revolving line of credit have a higher interest rate than non revolving | typically non revolving forms of credit such as installment loans will have lower interest rates than revolving lines of credit 2 | |
what are some examples of revolving personal credit | revolving credit accounts are quite common some examples include credit cards personal lines of credit or home equity lines of credit | |
are revolving credit accounts secured or unsecured | revolving credit accounts can be either secured or unsecured for example a home equity line of credit is secured by the equity in your home a credit card on the other hand is unsecured the bottom linea revolver can refer to either the revolving credit account itself or the borrower more often it refers to the account revolving credit allows for flexible spending over time but beware high interest can cause you to spend more than you intended on some revolving accounts such as credit cards | |
what is revolving credit | revolving credit is a credit line that remains available even as you pay the balance borrowers can access credit up to a certain amount and then have ongoing access to that amount of credit they can repay the balance in full or make regular payments each payment minus the interest and fees charged opens the credit again to the account holder examples of revolving credit include credit cards lines of credit and home equity lines of credit helocs they work differently than installment loans learn about the pros and cons of a revolving line of credit investopedia lara antal | |
when a borrower is approved for revolving credit the bank or financial institution establishes a credit limit that can be used over and over again all or in part a credit limit is the maximum amount of money a financial institution is willing to extend to a customer seeking funds | revolving credit is generally approved with no date of expiration the bank will allow the agreement to continue as long as the account remains in good standing over time the bank may raise the credit limit to encourage its most dependable customers to spend more 1borrowers pay interest monthly on the current balance owed because of the convenience and flexibility of revolving credit a higher interest rate typically is charged on it compared to traditional installment loans revolving credit can come with variable interest rates that may be adjusted the costs of revolving credit vary widely lenders consider several factors about a borrower s ability to pay before setting a credit limit for an individual the factors include credit score current income and employment stability for an organization or company the bank reviews the balance sheet income statement and cash flow statement 3revolving credit examplescommon examples of revolving credit include credit cards home equity lines of credit helocs and personal and business lines of credit credit cards are the best known type of revolving credit however there are numerous differences between a revolving line of credit and a consumer or business credit card first there is no physical card involved in using a line of credit as there is with a credit card lines of credit are typically accessed via checks issued by the lender second a line of credit does not require the customer to make a purchase it allows money to be transferred into a customer s bank account for any reason without requiring an actual transaction using that money this is similar to a cash advance on a credit card but does not typically come with the high fees and higher interest charges that a cash advance can trigger types of revolving creditrevolving credit can be secured or unsecured there are major differences between the two a secured line of credit is guaranteed by collateral such as a home in the case of a heloc unsecured revolving credit is not guaranteed by collateral or an asset for example a credit card unless it is a secured credit card which does require the consumer to make a cash deposit as collateral a company may have its revolving line of credit secured by company owned assets in this case the total credit extended to the customer may be capped at a certain percentage of the secured asset for example a financial institution may set a credit limit at 80 of a company s inventory balance if the company defaults on its obligation to repay the debt the financial institution can foreclose on the secured assets and sell them to pay off the debt 4because unsecured credit is riskier for lenders it typically has higher interest rates advantages and disadvantages of revolving creditthe main advantage of revolving credit is that it allows borrowers the flexibility to access money when they need it many businesses small and large depend on revolving credit to keep their access to cash steady through seasonal fluctuations in their costs and sales as with consumers rates for business lines of credit vary widely depending on the credit history of the business and whether the line of credit is secured with collateral and like consumers businesses can keep their borrowing costs minimal by paying down their balances to zero every month 5revolving credit can be a risky way to borrow if not managed prudently a significant part of your credit score 30 is your credit utilization rate a high credit utilization rate can have a negative impact on your credit score most credit experts recommend keeping this rate at 30 or below 1revolving credit vs installment loanrevolving credit differs from an installment loan which requires a fixed number of payments including interest over a set period of time revolving credit requires only a minimum payment plus any fees and interest charges with the minimum payment based on the current balance revolving credit is a good indicator of credit risk and has the potential to impact an individual s credit score considerably installment loans on the other hand can be viewed more favorably on an individual s credit report assuming all payments are made on time revolving credit implies that a business or individual is pre approved for a loan a new loan application and credit reevaluation do not need to be completed for each instance of using the revolving credit 1also revolving credit is intended for shorter term and smaller loans for larger loans financial institutions require more structure including installment payments in preset amounts | |
is it good to have revolving credit | revolving credit is good to have in many cases such as when you need access to funds and you want to pay them back over time but if not used responsibly revolving credit could cause financial strain | |
what is a good amount of revolving credit to have | a good amount of revolving credit to have to best help your credit score is below 30 of your available credit if you spend more than 30 of your available credit your credit score will likely decline generally the lower your credit utilization ratio or the proportion of your balance to available credit the better your credit score 6 | |
how can revolving credit help your credit score | revolving credit can boost your credit score if you use it responsibly to get the most out of revolving credit make your minimum payments on time try to make more than the minimum payment or pay off your balances in full each month to avoid interest charges and aim to keep your credit utilization ratio below 30 the bottom linerevolving credit is a credit line that can be a valuable financial tool to help you pay for things if you use revolving credit responsibly you can build your credit score and potentially enjoy rewards like cash back or travel points if you have a revolving credit line be sure you make minimum payments on time or your credit score could suffer | |
what is a revolving door | the term revolving door refers to the movement of high level employees from public sector jobs to private sector jobs and vice versa the idea is that there is a revolving door between the two sectors as many legislators and regulators become lobbyists and consultants for the industries they once regulated and some private industry heads or lobbyists receive government appointments that relate to their former private posts such instances have grown in democracies in recent years with increased lobbying efforts and have led to debate over the extent former government officials are allowed to utilize connections formed and knowledge attained in previous jobs in public service to enrich themselves or be overly influential on shaping or watering down pending legislation | |
how revolving doors work | while it is inevitable that workers switch between the public and private sectors the growing influence of money in politics has placed the revolving door phenomenon into the spotlight between 1998 and 2022 the amount of money spent on lobbying in the united states more than doubled to 3 1 billion 1 it has led to the concern that corporations and special interest groups are able to leverage their money to buy influence and access to key politicians the revolving door may also lead to conflicts of interest as the regulatory and legislative decisions politicians make may directly benefit them soon after they leave office and work in the private sector the revolving door phenomenon is present in numerous industries levels of government and political affiliations lobbyists who have participated in the revolving door say that they are cashing in on their expertise rather than their connections what you know is more important than who you know for example the argument for having a revolving door is that having specialists within private lobby groups and running public departments ensures a higher quality of information when making regulatory decisions one study that investigated this assertion found that when a u s senator or representative leaves office the lobbyist that worked with them sees their earnings drop by an average of 20 2 this translates to 177 000 per year and may go on for three years or longer proving that it is difficult for a lobbyist to offset the loss of a key political contact special considerationspolicies meant to prevent or limit revolving door practices are few and limited in effect in the world s largest democracies in the united states there are detailed rules that govern how and when ex government officials may be employed in the private sector for example former government officials who make decisions on contracts must either wait a year to take a job with a military contractor or move to a role or unit with no connection to their government work 3however this rule does not apply to policymakers who may join corporations and company boards immediately in france there is a three year waiting period after leaving public service to work in the private sector 4 japan which has made attempts to limit their own revolving door issues has a term for career public servants who leave to join the private sector amakudari or descent from heaven | |
what is a revolving loan facility | a revolving loan facility also called a revolving credit facility or simply revolver is a form of credit issued by a financial institution that provides the borrower with the ability to draw down or withdraw repay and withdraw again 1 a revolving loan is considered a flexible financing tool due to its repayment and re borrowing accommodations it is not considered a term loan because during an allotted period of time the facility allows the borrower to repay the loan or take it out again in contrast a term loan provides a borrower with funds followed by a fixed payment schedule | |
how a revolving loan facility works | a revolving loan facility is typically a variable line of credit used by public and private businesses the line is variable because the interest rate on the credit line can fluctuate in other words if interest rates rise in the credit markets a bank might increase the rate on a variable rate loan the rate is often higher than rates charged on other loans and changes with the prime rate or another market indicator the financial institution typically charges a fee for extending the loan criteria for approval of the loan depends on the stage size and industry in which the business operates the financial institution typically examines the company s financial statements including the income statement statement of cash flows and balance sheet when deciding whether the business can repay a debt the odds of the loan getting approved increases if a company can demonstrate steady income strong cash reserves and a good credit score the balance on a revolving loan facility may move between zero and the maximum approved value | |
how do businesses use a revolving loan facility | a revolving loan or line facility allows a business to borrow money as needed for funding working capital needs and continuing operations a revolving line is especially helpful during times of revenue fluctuations since bills and unexpected expenses can be paid by drawing from the loan drawing against the loan brings down the available balance whereas making payments on the debt brings up the available balance the financial institution may review the revolving loan facility annually if a company s revenue shrinks the institution may decide to lower the maximum amount of the loan therefore it is important for the business owner to discuss the company s circumstances with the financial institution to avoid a reduction in or termination of the loan a revolving loan facility provides a variable line of credit that allows people or businesses great flexibility with the funds they are borrowing example of a revolving loan facilitysupreme packaging secures a revolving loan facility for 500 000 the company uses the credit line for covering payroll as it waits for accounts receivable payments although the business uses up to 250 000 of the revolving loan facility each month it pays off most of the balance and monitors how much available credit remains because another company signed a 500 000 contract for supreme packaging to package its products for the next five years the packaging company is using 200 000 of its revolving loan facility for purchasing the required machinery | |
how long do you have to repay a revolving loan facility | unlike a term loan with fixed payments a revolving loan facility has no established term money is withdrawn by the company reducing the amount available to borrow it is then paid back replenishing the line of credit | |
are all revolving loan facilities for businesses | for the purposes of this article yes they are limited to businesses home equity lines of credit or personal lines of credit operate on the same principles for personal use | |
do you pay interest on a revolving loan facility | yes a revolving loan facility is a loan just like any other term loan the difference is that instead of receiving borrowed money in a lump sum the money can be used as needed repaid and then used again the bottom linefor businesses with fluctuating income a revolving loan facility can be a great option for meeting payroll or covering unforeseen expenses establishing a revolving loan facility with your bank could be a wise move for your business | |
what is rho | rho is the rate at which the price of a derivative changes relative to a change in the risk free rate of interest rho measures the sensitivity of an option or options portfolio to a change in interest rate rho may also refer to the aggregated risk exposure to interest rate changes that exist for a book of several options positions for example if an option or options portfolio has a rho of 1 0 then for every 1 percentage point increase in interest rates the value of the option or portfolio increases 1 percent options that are most sensitive to changes in interest rates are those that are at the money and with the longest time to expiration in mathematical finance quantities that measure the price sensitivity of a derivative to a change in an underlying parameter are known as the greeks the greeks are important tools in risk management because they allow a manager trader or investor to measure the change in value of an investment or portfolio to a small change in a parameter more important this measurement allows the risk to be isolated thus allowing a manager trader or investor to rebalance the portfolio to achieve a desired level of risk relative to that parameter the most common greeks are delta gamma vega theta and rho rho calculation and rho in practicethe exact formula for rho is complicated but it is calculated as the first derivative of the option s value with respect to the risk free rate rho measures the expected change in an option s price for a 1 percent change in a u s treasury bill s risk free rate for example assume that a call option is priced at 4 and has a rho of 0 25 if the risk free rate rises 1 percent say from 3 percent to 4 percent the value of the call option would rise from 4 to 4 25 call options generally rise in price as interest rates increase and put options generally decrease in price as interest rates increase thus call options have positive rho while put options have negative rho assume that put option is priced at 9 and has a rho of 0 35 if interest rates were to decrease from 5 percent to 4 percent then the price of this put option would increase from 9 to 9 35 in this same scenario assuming the call option mentioned above its price would decrease from 4 to 3 75 rho is larger for options that are in the money and decrease steadily as the option changes to become out of the money also rho increases as the time to expiration increases long term equity anticipation securities leaps which are options that generally have expiration dates that are greater than one year away are far more sensitive to changes in the risk free rate and thus have larger rho than shorter term options though rho is a primary input in the black scholes options pricing model a change in interest rates generally has a minor overall impact on the pricing of options because of this rho is usually considered to be the least important of all the option greeks | |
what is ricardian equivalence | ricardian equivalence is an economic theory that says that financing government spending out of current taxes or future taxes and current deficits will have equivalent effects on the overall economy 1 this means that attempts to stimulate an economy by increasing debt financed government spending will not be effective because investors and consumers understand that the debt will eventually have to be paid for in the form of future taxes understanding ricardian equivalencegovernments can finance their spending either by taxing or by borrowing and presumably taxing later to service the debt in either case real resources are withdrawn from the private economy when the government purchases them but the method of financing is different ricardo argued that under certain circumstances even the financial effects of these can be considered equivalent because taxpayers understand that even if their current taxes are not raised in the case of deficit spending their future taxes will go up to pay the government debt as a result they will be forced to set aside some current income to save up to pay the future taxes because these savings necessarily involve forgone current consumption in a real sense they effectively shift the future tax burden into the present in either case the increase in current government spending and consumption of real resources is accompanied by a corresponding decrease in private spending and consumption of real resources financing government spending with current taxes or deficits and future taxes are thus equivalent in both nominal and real terms economist robert barro formally modeled and generalized ricardian equivalence based on the modern economic theory of rational expectations and the lifetime income hypothesis 2 barro s version of ricardian equivalence has been widely interpreted as undermining keynesian fiscal policy as a tool to boost economic performance because investors and consumers adjust their current spending and saving behaviors based on rational expectations of future taxation and their expected lifetime after tax income reduced private consumption and investment spending will offset any government sending in excess of current tax revenues the underlying idea is that no matter how a government chooses to increase spending whether through borrowing more or taxing more the outcome is the same and aggregate demand remains unchanged key assumptions of the ricardian equivalencethere are several assumptions to the ricardian equivalence the top five assumptions include the following the theory states that individuals can borrow and lend freely at the same interest rate as the government in this idealized scenario there are no credit constraints and everyone has equal access to financial markets this allows consumers to smooth their consumption over time borrowing when their income is low and saving when it s high the theory suggests that individuals make economic decisions based on a comprehensive understanding of future economic conditions consumers are expected to accurately anticipate future tax changes or increases and adjust their saving behavior accordingly the theory assumes that taxes are levied as lump sum amounts that do not affect individuals economic choices this means that taxes don t influence decisions about work savings or consumption if someone gets a lump sum tax payment it won t actually influence their spending habits the theory holds that individuals either live forever or care about future generations as much as they care about themselves this obviously means that the assumption is the current generations fully account for the tax burdens that will be faced by their descendants and make the decisions for these individuals in the future even at short term deficits such as paying a gift tax the model assumes that individuals have perfect knowledge about their future income streams and tax liabilities this allows them to make precise calculations about their lifetime resources and adjust their current consumption and saving accordingly many modern economists acknowledge that ricardian equivalence depends on assumptions that may not always be realistic arguments against the ricardian equivalencesome economists including ricardo himself have argued that ricardo s theory is based upon unrealistic assumptions for instance the ricardian equivalence assumes that individuals can borrow and lend freely at the same interest rate as the government however capital markets are far from perfect many individuals face credit constraints higher interest rates or may be unable to borrow at all due to factors such as low income poor credit history or lack of collateral this imperfection means that people can t always smooth their consumption over time as the theory suggests leading to a breakdown of the equivalence the theory also assumes that people consider the tax burdens of future generations as if they were their own however individuals have finite lifespans and may not factor in tax increases that will occur after their death behavioral economics may suggest that some people exhibit myopic behavior focusing more on short term benefits and immediate gratification rather than long term financial planning last the ricardian equivalence doesn t account for potential keynesian multiplier effects of government spending in keynesian economics government spending can have a stimulative effect on the economy this means the government can aid in increasing aggregate demand and potentially leading to higher output and employment these effects could outweigh any increase in private saving especially in times of economic downturn when there s significant slack in the economy the presence of these multiplier effects challenges the ricardian notion that government borrowing is fully offset by private saving real world evidence of ricardian equivalencethe theory of ricardian equivalence has been largely dismissed by keynesian economists and ignored by public policy makers who follow their advice however there is some evidence that it has validity in a study of the effects of the 2008 financial crisis on european union nations a strong correlation was found between government debt burdens and net financial assets accumulated in 12 of the 15 nations studied in this case ricardian equivalence holds up countries with high levels of government debt have comparatively high levels of household savings 3in addition a number of studies of spending patterns in the u s have found that private sector savings increase by about 30 cents for every additional 1 of government borrowing this suggests that the ricardian theory is at least partially correct 4overall however the empirical evidence for ricardian equivalence is somewhat mixed and likely depends on how well the assumptions that consumers and investors will form rational expectations base their decisions on their lifetime income and not face liquidity constraints on their behavior will actually hold in the real world | |
what is ricardian equivalence | ricardian equivalence is an economic theory proposing that the method of financing government spending whether through taxes or debt does not affect the overall economy it suggests that rational consumers will save any extra money from tax cuts to pay for anticipated future tax increases who proposed the ricardian equivalence theory the concept was first introduced by british economist david ricardo in the early 19th century however the modern version of the theory is largely attributed to harvard economist robert barro who formalized and expanded upon ricardo s original ideas in a 1974 paper | |
how does ricardian equivalence affect fiscal policy | if ricardian equivalence holds it implies that fiscal policy changes in government spending or taxation would be ineffective in stimulating the economy | |
how does ricardian equivalence impact consumer behavior | under ricardian equivalence consumers are assumed to be forward looking and rational when the government cuts taxes and increases borrowing consumers anticipate future tax increases and save the extra income rather than spending it however behavioral economics suggests this may not always happen because individuals are not always rational the bottom linethe ricardian equivalence theorem states that government deficit spending is counterbalanced by increased private saving as individuals anticipate future tax hikes to repay the debt consequently the choice between tax financed or debt financed government expenditure becomes economically neutral as rational consumers adjust their behavior to offset fiscal policy changes | |
what is a rider | a rider is an insurance policy provision that adds benefits to or amends the terms of a basic insurance policy riders provide insured parties with additional coverage options or they may even restrict or limit coverage there is an additional cost if a party decides to purchase a rider most are low in cost because they involve minimal underwriting a rider is also referred to as an insurance endorsement it can be added to policies that cover life homes autos and rental units understanding a ridersome policyholders have specific needs not covered by standard insurance policies so riders help them create insurance products that meet those needs insurance companies offer supplemental insurance riders to customize policies by adding varying types of additional coverage the benefits of insurance riders include increased savings from not purchasing a separate policy and the option to buy different coverage at a later date say an insured person has a terminal illness and adds an accelerated death benefit rider on a life insurance policy this rider would provide the insured with a cash benefit while living the insured may use these funds how they wish perhaps to improve their quality of life or to pay for medical and final expenses when the insured passes away their designated beneficiaries receive a reduced death benefit the face value less the portion used under the accelerated death benefit rider buying an insurance rider is up to the insured party who should weigh the cost against their individual needs although riders may sound appealing they come at a cost on top of the premiums for the policy itself certain homeowner insurance policies come with extra earthquake riders but someone who doesn t live near a fault line probably doesn t need this additional coverage another thing to consider a rider may duplicate coverage so it s important to look over the basic insurance contract before adding a rider to an insurance policy the holder should weigh the cost of the rider and decide whether they really need it it is also wise to check that the rider does not duplicate coverage already included in the basic policy types of ridersriders come in various forms including long term care term conversion waiver of premiums and exclusionary long term care ltc coverage is often available as a rider to a cash value insurance product such as universal whole or variable life insurance a rider can address specific long term care issues the funds reduce the policy s death benefit when they are used designated beneficiaries receive the death benefit less the amount paid out under the long term care rider in some cases the policyholder s needs may exceed the total benefit of the life insurance policy so it may be more advantageous to purchase a stand alone ltc policy if the ltc rider is unused the policyholder saves in costs when compared to purchasing a stand alone ltc policy term life insurance provides coverage for a limited time typically 10 to 30 years once the policy expires the policyholder is not guaranteed new coverage at the same terms the policyholder s medical condition may make it difficult or impossible to obtain another policy a term conversion rider allows the policyholder to convert an existing term life insurance to permanent life insurance without a medical exam this is typically favorable to young parents seeking to lock in coverage to protect their families in the future this rider is generally available only when the policy begins and may not be available in every state under the waiver of premium rider the insured party is relieved of premium payments if the policyholder becomes critically ill disabled or seriously injured there may be certain requirements to add this rider such as age limits and certain health requirements exclusionary riders restrict coverage under a policy for a specific event or condition exclusionary riders are mainly found in individual health insurance policies for example coverage can be restricted for a preexisting condition detailed in the policy provisions as of september 2010 the affordable care act aca prohibited exclusionary riders from being applied to children exclusionary riders have not been permitted in any healthcare insurance since 2014 example of a ridera typical homeowners insurance policy includes coverage for structural damage personal property damage or loss and personal liability coverage however each standard protection is also subject to coverage limits or restrictions a rider broadens the standard coverage for example an expensive piece of jewelry can be protected by extending personal property coverage through a scheduled personal property rider a homeowners policy may have a coverage limit of 50 000 for personal property but it might also have a sub limit of 1 500 for jewelry if valuable jewelry is stolen or damaged by a fire the policyholder would only be reimbursed up to 1 500 to help replace it a rider would extend the reimbursement amount for certain valuable items a standalone insurance policy will typically offer more coverage than a rider thus check with an insurance expert whether you should invest in a whole new policy rather than rely on a rider for coverage rider insurance faqsan insurance rider is an adjustment or an add on to a basic insurance policy riders are designed to provide additional benefit over the stated coverage in the basic policy a rider is useful for tailoring an insurance policy to the precise needs of the insured entity a rider is added to an existing policy in exchange for a fee payable to the insurer riders allow insurance policies to be tailored to meet the needs of the policyholder for example a homeowner might need additional personal property insurance if they have certain valuable items or they may need additional structural insurance if they live in a region where inclement weather is a threat to their home life insurance riders allow policyholders to purchase more insurance as they age doing so might be cheaper than going through the typical underwriting process required for a new policy also some insurance policies allow for the accumulation of cash value for the policy on a tax deferred basis riders for homeowners include the following scheduled personal property coverage this rider extends coverage for valuables such as jewelry and antiques and protects them against additional risks that a standard homeowners policy does not cover for example loss or misplacement water backup coverage a homeowner s policy may not cover water damage from a backed up drain or sump pump this type of rider would cover the cost of backed up drains and water damage building code coverage if a home is not up to building code standards when damage occurs the owner may have to pay out of pocket to bring the structure up to code this type of rider will pay the additional cost of bringing the home up to code after a covered claim business property coverage if you run a business out of your home you may need additional coverage to protect business equipment or products stored in your home identify theft restoration coverage having your identity stolen can incur costs such as legal fees this type of rider would ensure that the policyholder is reimbursed for any expenses should their identity be stolen most insurance companies will allow you to drop a rider from a policy simply by filling out a form that authorizes its removal | |
what is a rider | a rider is an insurance policy provision that adds benefits to or amends the terms of a basic insurance policy riders provide insured parties with additional coverage options or they may even restrict or limit coverage there is an additional cost if a party decides to purchase a rider most are low in cost because they involve minimal underwriting a rider is also referred to as an insurance endorsement it can be added to policies that cover life homes autos and rental units understanding a ridersome policyholders have specific needs not covered by standard insurance policies so riders help them create insurance products that meet those needs insurance companies offer supplemental insurance riders to customize policies by adding varying types of additional coverage the benefits of insurance riders include increased savings from not purchasing a separate policy and the option to buy different coverage at a later date say an insured person has a terminal illness and adds an accelerated death benefit rider on a life insurance policy this rider would provide the insured with a cash benefit while living the insured may use these funds how they wish perhaps to improve their quality of life or to pay for medical and final expenses when the insured passes away their designated beneficiaries receive a reduced death benefit the face value less the portion used under the accelerated death benefit rider buying an insurance rider is up to the insured party who should weigh the cost against their individual needs although riders may sound appealing they come at a cost on top of the premiums for the policy itself certain homeowner insurance policies come with extra earthquake riders but someone who doesn t live near a fault line probably doesn t need this additional coverage another thing to consider a rider may duplicate coverage so it s important to look over the basic insurance contract before adding a rider to an insurance policy the holder should weigh the cost of the rider and decide whether they really need it it is also wise to check that the rider does not duplicate coverage already included in the basic policy types of ridersriders come in various forms including long term care term conversion waiver of premiums and exclusionary long term care ltc coverage is often available as a rider to a cash value insurance product such as universal whole or variable life insurance a rider can address specific long term care issues the funds reduce the policy s death benefit when they are used designated beneficiaries receive the death benefit less the amount paid out under the long term care rider in some cases the policyholder s needs may exceed the total benefit of the life insurance policy so it may be more advantageous to purchase a stand alone ltc policy if the ltc rider is unused the policyholder saves in costs when compared to purchasing a stand alone ltc policy term life insurance provides coverage for a limited time typically 10 to 30 years once the policy expires the policyholder is not guaranteed new coverage at the same terms the policyholder s medical condition may make it difficult or impossible to obtain another policy a term conversion rider allows the policyholder to convert an existing term life insurance to permanent life insurance without a medical exam this is typically favorable to young parents seeking to lock in coverage to protect their families in the future this rider is generally available only when the policy begins and may not be available in every state under the waiver of premium rider the insured party is relieved of premium payments if the policyholder becomes critically ill disabled or seriously injured there may be certain requirements to add this rider such as age limits and certain health requirements exclusionary riders restrict coverage under a policy for a specific event or condition exclusionary riders are mainly found in individual health insurance policies for example coverage can be restricted for a preexisting condition detailed in the policy provisions as of september 2010 the affordable care act aca prohibited exclusionary riders from being applied to children exclusionary riders have not been permitted in any healthcare insurance since 2014 example of a ridera typical homeowners insurance policy includes coverage for structural damage personal property damage or loss and personal liability coverage however each standard protection is also subject to coverage limits or restrictions a rider broadens the standard coverage for example an expensive piece of jewelry can be protected by extending personal property coverage through a scheduled personal property rider a homeowners policy may have a coverage limit of 50 000 for personal property but it might also have a sub limit of 1 500 for jewelry if valuable jewelry is stolen or damaged by a fire the policyholder would only be reimbursed up to 1 500 to help replace it a rider would extend the reimbursement amount for certain valuable items a standalone insurance policy will typically offer more coverage than a rider thus check with an insurance expert whether you should invest in a whole new policy rather than rely on a rider for coverage rider insurance faqsan insurance rider is an adjustment or an add on to a basic insurance policy riders are designed to provide additional benefit over the stated coverage in the basic policy a rider is useful for tailoring an insurance policy to the precise needs of the insured entity a rider is added to an existing policy in exchange for a fee payable to the insurer riders allow insurance policies to be tailored to meet the needs of the policyholder for example a homeowner might need additional personal property insurance if they have certain valuable items or they may need additional structural insurance if they live in a region where inclement weather is a threat to their home life insurance riders allow policyholders to purchase more insurance as they age doing so might be cheaper than going through the typical underwriting process required for a new policy also some insurance policies allow for the accumulation of cash value for the policy on a tax deferred basis riders for homeowners include the following scheduled personal property coverage this rider extends coverage for valuables such as jewelry and antiques and protects them against additional risks that a standard homeowners policy does not cover for example loss or misplacement water backup coverage a homeowner s policy may not cover water damage from a backed up drain or sump pump this type of rider would cover the cost of backed up drains and water damage building code coverage if a home is not up to building code standards when damage occurs the owner may have to pay out of pocket to bring the structure up to code this type of rider will pay the additional cost of bringing the home up to code after a covered claim business property coverage if you run a business out of your home you may need additional coverage to protect business equipment or products stored in your home identify theft restoration coverage having your identity stolen can incur costs such as legal fees this type of rider would ensure that the policyholder is reimbursed for any expenses should their identity be stolen most insurance companies will allow you to drop a rider from a policy simply by filling out a form that authorizes its removal | |
what is a right of first refusal | right of first refusal rofr also known as first right of refusal is a contractual right that someone has to match or decline to match an offer for an asset after other offers have been made the person who holds this right is entitled to enter a transaction before anyone else does if they decide not to enter the transaction the seller is free to entertain the other offers this is a popular clause among those who rent real estate because it gives them first crack at buying the properties they occupy it is also popular among venture capitalists looking for assurances that their investments will not be sold out from under them investopedia zoe hansen | |
how a right of first refusal works | right of first refusal clauses are similar to options contracts in that holders are granted rights but not obligations with an rofr the right holder has the right but not the obligation to match or decline to match an offer already made on an asset by another party the person who owns the asset is obligated to notify the right holder that they ve received an offer for their property so if a shareholder wants to sell their share and is subject to an rofr they must find someone willing to make an offer for that share once they have an offer they then must notify the right holder who can exercise their option to match that offer and purchase the share or refuse to match it and let another party purchase it rights of first refusal are usually requested by individuals or companies who want to see how an opportunity will turn out the right holder may prefer to get involved later rather than make a financial outlay and commitment right away a right of first refusal allows them to do so however the right holder generally only has a specified time before the seller can accept another offer moreover the right is also only valid with the seller with whom they contracted right of first refusal clauses can be customized to create variations of the standard agreement the parties involved can incorporate changes such as specifying how long the right is valid or allowing a third party nominated by the buyer to make the purchase a right of first offer rofo is different from the rofr it gives the holder the right to make an offer on an asset before the seller sells it to someone else under an rofr contract the seller must have an offer from another party and then notify the contract holder of that offer advantages and disadvantages of rights of first refusalrofr contracts usually favor buyers but these agreements also have cons special considerationsin the business world rights of first refusal are commonly seen in joint venture situations the partners in a joint venture generally possess the right of first refusal to buy out the stakes held by other partners who leave the venture rights of first refusal are a common feature in many other fields from real estate to sports and entertainment for example a publishing house may ask for the right of first refusal on future books by a new author | |
what is the meaning of right of first refusal | a right of first refusal is a contract with an asset owner that gives the holder of the right the ability to match or refuse to match an offer from another party to buy the asset | |
why is right of refusal bad | a right of first refusal is neither good nor bad it is simply a tool used by some to ensure they have the first claim on an asset or to ensure a buyer is waiting | |
what is the difference between an options contract and a right of first refusal | an options contract is an agreement whereby the contract buyer purchases the right but not the obligation to exercise the right and buy or sell shares of stock a right of first refusal is the right but not the obligation to match an offer someone else has made on an asset and purchase it the bottom linea right of first refusal is a contractual agreement between two parties that gives one the ability to be the first buyer this party can match an offer made by a third party and purchase an asset or they can refuse to match it in which case the seller can proceed with selling it to that third or another party these contracts are generally used by interested parties who don t want a contractual obligation to purchase an asset but do want the option to do so if other parties become interested in it | |
what is the right of rescission | the right of rescission is a legal right outlined in the federal truth in lending act tila that allows a borrower to cancel or rescind certain types of home loans within three days of closing on the loan this right is provided on a no questions asked basis and the lender must give up its claim to the property and refund all fees within 20 days of the borrower exercising their right of rescission 1understanding the right of rescissionthe tila enacted in 1968 and amended over the years is intended to curtail unfair and deceptive credit billing and credit card practices among other things it requires lenders to provide borrowers with relevant information about home loans and the right to cancel them in some instances the right of rescission was created to protect consumers from unscrupulous lenders giving borrowers at least a brief cooling off period and time to change their minds 2not all loan transactions come with the right of rescission it applies only to loans that use the person s existing home as collateral including certain home equity loans home equity lines of credit helocs reverse mortgages and refinances of mortgages it does not apply to mortgages used to buy or build a home or to purchase a second home or an investment property 34in addition the right does not apply if you are refinancing your mortgage with the same lender and aren t borrowing additional money as part of the refinance nor does it apply if your lender is a state agency however the federal trade commission ftc says you may have other cancellation rights under state or local law 4an eligible home can include a house condominium mobile home or houseboat 4 | |
how the three day cancellation rule works | the provision in the law allowing borrowers three days to change their mind and back out of a loan contract is known as the three day cancellation rule specifically the rule allows borrowers three business days including saturdays but not sundays to cancel the contract without penalty and for any reason 4the clock starts ticking only after you have signed the loan contract at closing received a truth in lending disclosure form from the lender and also received two copies of a truth in lending notice explaining your right to cancel according to the ftc if you didn t get the disclosure form or the two copies of the notice or if the disclosure or notice was incorrect you may have up to three years to cancel 4otherwise once all three of those things have happened you have until midnight of the third business day to cancel 4 | |
how to exercise the right of rescission | as mentioned the lender is required to provide you with a notice explaining your right to cancel and how to go about it basically you must mail or deliver a written notice to the lender that you are exercising your right to rescission and cancelling the loan the law written decades ago also allows for delivery by telegram 1 you cannot cancel by other means such as a phone call or in person conversation with the lender 4as the law explains notice is considered given when mailed when filed for telegraphic transmission or if sent by other means when delivered to the creditor s designated place of business 1 | |
how long is the right of rescission | the right of rescission lasts for just three business days starting from the point that all of the following have occurred | |
what happens if i don t receive the tila disclosure or the notice of my right to rescind | if you can prove that you never received these documents or that they contain inaccurate information then the three business day cooling off period could be extended for up to three years 14 | |
how do i cancel my loan agreement | the right of rescission procedure should be explained in the paperwork the lender must provide you as part of the loan process generally you will need to indicate your intention to cancel the loan in writing and send it to the lender before the deadline passes 4 | |
does the truth in lending act apply to auto loans | the truth in lending act doesn t provide a right to rescission for auto loans it does however require lenders to provide borrowers with certain information regarding the terms of the loan before they sign such as the annual percentage rate apr and other costs and fees the amount of the monthly payment and the total projected cost over the life of the loan 6 | |
what is the cooling off rule | the cooling off rule is an ftc rule that applies to certain types of purchases but not to real estate vehicles or many other things in applicable situations sellers are required to explain your right to cancel and to provide you with forms for that purpose as with the right of rescission the cooling off period is three days 7the bottom linethe right of rescission allows consumers a brief period of time to cancel certain types of home loans if they change their mind if you are planning to sign a loan contract and have any doubts about whether you will want to proceed with the arrangement it s a good idea to find out beforehand whether the right of rescission applies | |
what is a right to work law | a right to work rtw law gives workers the freedom to choose whether or not to join a labor union in the workplace this law also makes it optional for employees in unionized workplaces to pay for union dues or other membership fees required for union representation whether they are in the union or not right to work is also known as workplace freedom or workplace choice while the name of the law implies that it provides freedom to workers critics argue that it weakens unions and empowers corporations instead understanding right to work lawscurrently 27 states have passed right to work laws giving employees the choice of whether or not to join a union right to work laws in these states prohibit contracts that require workers to join a labor union in order to get or keep a job 1states without right to work laws require employees to pay union dues and fees as a term for employment while labor unions are still fully operative in right to work states the law protects these states employees by making payment of union fees an elective decision not bound to the employees employment contracts 2as of early 2024 there is no federal right to work law the law only applies in states that choose to enact it history of right to work lawsin 1935 the national labor relations act nlra or the wagner act was signed into law by president franklin roosevelt the act protected the rights of employees to create a self organized organization and mandated employers to engage in collective bargaining and employment negotiations with these self organized organizations called labor unions employees were also compelled to pay the union for representing and protecting their interests the nlra required union membership as a condition for employment thereby restricting employment to union members only 3in 1947 president harry truman amended parts of the nlra when the taft hartley act was passed during his presidency truman initially vetoed the bill when it arrived on his desk stating that the act would be unfair to the working people of this country understanding that it would serve to weaken union membership and collective bargaining power in the end congress overturned truman s veto 4the taft hartley act effectively created current right to work laws which allow states to prohibit compulsory membership in a union as a condition for employment in the public and private sectors of the country 5in february 2023 congress re introduced the national right to work act it would give employees nationwide a choice to opt out of joining or paying dues to unions 6 the act was also introduced in 2019 and 2017 but stalled 78in march 2021 the united states house of representatives passed the protecting the right to organize act pro act 9 the pro union legislation overrides right to work laws and would make it easier to form unions the pro act faces an uphill battle in the senate as most republicans oppose it the following states have right to work laws alabama arizona arkansas kansas florida georgia idaho indiana iowa kentucky louisiana michigan mississippi nebraska nevada north carolina north dakota oklahoma south carolina south dakota tennessee texas utah virginia west virginia wisconsin and wyoming 2 arguments for and against right to work lawsproponents of right to work laws agree that workers shouldn t be obliged to join a union if they are not interested these supporters believe that states with a right to work law attract more businesses than states without it this is because companies would rather function in an environment where workplace disputes or threats of labor strikes would not interrupt their daily business operations advocates of these laws also agree that right to work states have a higher employment rate after tax income for employees and a lower cost of living than states that have not implemented this law critics maintain that workers in right to work states earn lower wages compared to those in the states that don t have the law opponents also argue that since federal law requires unions to represent all workers regardless of whether they pay union dues free riders are encouraged to benefit from union services at no cost to them this increases the cost of operating and maintaining a union organization in addition critics claim that if businesses are given a choice to do without unions they are likely to lower the safety standards set in place for their employees and by making it harder for unions to operate and represent workers economic inequality will be exacerbated and corporate power over employees will increase significantly | |
what has been the effect of right to work laws on employment | economists have looked at employment growth in regions with and without right to work rtw laws over the past decades on net they find that states with rtw laws have shown an increase in the manufacturing share of employment and increased labor participation however while employment levels are higher average wages among workers also tend to be lower meanwhile dividends to shareholders and executive compensation has increased post rtw | |
what has been the effect of right to work laws on unions | studies show that states with right to work laws have seen a dramatic decrease in union membership and unionization rates other research suggests that rtw laws impact corporate policies by decreasing that bargaining power | |
how many states have right to work laws | as of 2024 27 out of the 50 states in the u s have right to work laws in place 2the bottom lineright to work laws prohibit unions and employers from making security agreements that could force workers to become paying union members while these types of laws may appear to give workers more freedom to choose whether or not to join a union or pay union fees or dues critics argue that such laws actually undermine worker solidarity and give more power to employers research shows that states with right to work laws feature higher employment rates but lower average wages and union membership than states without it at present there is no federal right to work law but 27 states have one on the books | |
what is a rights offering issue | a rights offering rights issue is a group of rights offered to existing shareholders to purchase additional stock shares known as subscription warrants in proportion to their existing holdings these are considered to be a type of option since they give a company s stockholders the right but not the obligation to purchase additional shares in the company in a rights offering the subscription price at which each share may be purchased is generally discounted relative to the current market price before the shareholder has paid for the new shares they are known as nil paid shares once they pay for the shares they are referred to as fully paid rights rights are often transferable allowing the holder to sell them in the open market | |
how a rights offering issue works | in a rights offering each shareholder receives the right to purchase a pro rata allocation of additional shares at a specific price and within a specific period usually 16 to 30 days shareholders notably are not obligated to exercise this right a rights offering is effectively an invitation to existing shareholders to purchase additional new shares in the company more specifically this type of issue gives existing shareholders securities called rights which well give the shareholders the right to purchase new shares at a discount to the market price on a stated future date the company is giving shareholders a chance to increase their exposure to the stock at a discount price but until the date at which the new shares can be purchased shareholders may trade the rights on the market the same way that they would trade ordinary shares the rights issued to a shareholder have value thus compensating current shareholders for the future dilution of their existing shares value dilution occurs because a rights offering spreads a company s net profit over a wider number of shares thus the company s earnings per share or eps decreases as the allocated earnings result in share dilution types of rights offeringsthere are two general types of rights offerings direct rights offerings and insured standby rights offerings in some cases rights issued are not transferable these are known as non renounceable rights in other cases the beneficiary of a rights issue may sell them to another party advantages and disadvantages of rights offeringscompanies generally offer rights when they need to raise money examples include when there is a need to pay off debt purchase equipment or acquire another company in some cases a company may use a rights offering to raise money when there are no other viable financing alternatives other significant benefits of a rights offering are that the issuing company can bypass underwriting fees there is no shareholder approval needed and market interest in the issuer s common stock generally peaks for existing shareholders rights offerings present the opportunity to purchase additional shares at a discount sometimes rights offerings present disadvantages to the issuing company and existing shareholders shareholders may disapprove because of their concern with dilution the offering may result in more concentrated investor positions the issuing company in an attempt to raise capital may find that additional required filings and procedures associated with the rights offering are too costly and time consuming the costs of the rights offering may outweigh the benefits cost benefit principle | |
why would a company do a rights offering | the main reason to do a rights offering is to raise capital the capital can be used to expand the business or pay down existing debt or any other need companies may issue rights offerings to existing shareholders as a benefit to shareholders as well as a way to avoid the time consuming and costly process of underwriting and releasing more shares to the public | |
how do rights offerings affect a company s stock price | rights offerings dilute the value of existing shares because more shares have been released through the rights offering this can harm the stock price as well as the fact that a rights offering can be associated with companies that are struggling financially so investor confidence is diminished reducing the stock price | |
do i have to purchase stock through a rights offering | existing shareholders are not obligated to purchase additional stock through a rights offering the offering simply offers them a chance to purchase more stock the bottom linerights offerings are additional shares of company stock offered to existing shareholders who are not obligated to buy the additional shares the shares are offered at a discount which is an incentive used to entice shareholders to buy stock companies issue rights offerings in order to raise capital for various reasons | |
what does ring fence mean | the term ring fence refers to the creation of a virtual barrier that segregates a portion of a company s financial assets from the rest this may be done to reserve money for a specific purpose to reduce taxes on the individual or company or to protect the assets from losses incurred by riskier operations moving a portion of assets offshore to reduce an investor s net worth or lower the taxes due on income is one example of ring fencing understanding ring fencesthe term has its origins in the ring fences that are built to keep farm animals in and predators out in financial accounting it is used to describe a number of strategies that are employed to protect a portion of assets from being mixed with the rest ring fencing may involve transferring a portion of assets from one high tax jurisdiction to another with lower or no taxes or less onerous regulations in other cases it may be used to keep the money in reserve for a specific purpose it also may be done to make the money unavailable for another purpose this is the intent of the british ring fencing law which went into effect at the beginning of 2019 it requires financial institutions to ring fence their consumer banking activities to protect customer bank deposits from potential investment banking losses the institutions were forced to recreate their banking arms as separate entities each with its own board 1the law intends to forestall another bank bailout like the one that followed the 2008 financial crisis the government bailout was forced by the perceived vulnerability of ordinary consumers and their savings to a collapse of the big banking institutions 12britain passed a law at the start of 2019 that requires financial institutions to ring fence their everyday banking activities from their investment arms ring fencing kicks in for banks that have more than 25 billion in core deposits 3advantages and disadvantages of ring fencingone of the primary benefits of using ring fencing as a strategy is that it provides a layer of protection over certain business assets it protects these assets from market risk volatility taxation insolvency and even seizures this strategy also helps keep the financial system sound and helps provide banks with a safety net that s because core assets are shielded from non core ones to prevent any major ripple effect when the economy tanks as it did before the great recession this puts less of an onus on taxpayers if banks succumb to economic pressure in the future the same way they did when the government had to bail them out after the financial crisis the premise behind ring fencing is that it separates core assets such as retail banking from those that are deemed to be non core assets like investment arms the problem with this is that separating groups of assets may lead to a reduction in oversight and the weakening of risk management 4banks and other organizations that are required to ring fence may take advantage of the fact that they must separate their assets which could lead to a beneficial end goal this includes more favorable tax treatment if they move their non core assets offshore which could lead to a drop in tax revenue for the home country protects against certain risksleads to a safer and secure financial systemreduces oversight and weakens risk managementmoving certain assets offshore may lead to drop in tax revenueoffshore ring fencingthe term is often used in the u s to describe the transfer of assets from one jurisdiction to another usually offshore in order to reduce an investor s verifiable income or reduce the investor s tax bill it also may be used to shield some assets from seizure by debtors it may be legal to ring fence assets to reduce taxation or avoid regulation as long as it stays within the limits set in the laws and regulations of the home country the limit typically is a certain percentage of the annual net worth of the business or individual meaning that the dollar amount will vary over time ring fencing can also describe earmarking assets for a particular purpose for example a savings account may be ring fenced for retirement a company may ring fence its pension fund to protect it from being drained for other business expenditures | |
what is the objective of ring fencing | the primary goal of ring fencing is to separate one group of assets from another this is generally done to keep core assets protected from volatility and other risks ring fencing is common with banks when core retail banking segments are separated from their investment arms if they are deemed too big to fail this layer of protection shields the taxpayer and the government from bearing the financial burden of bailing out banks in the event of an economic crisis | |
why was ring fencing introduced in the united kingdom | ring fencing was introduced by the british government in january 2019 the goal is to strengthen the country s banking and financial system by requiring banks to divide their core retail banking from other divisions such as international and investment activities doing this helps protect the retail banking sector from the bank s riskier ventures 5 | |
what is the british government s threshold for ring fencing | the british government introduced a 25 billion threshold on core deposits when it implemented the ring fencing rule in january 2019 this means that eligible banks must ring fence assets above this limit as of 2023 3 this threshold could be raised to 35 billion as the government is reviewing proposals to further strengthen the country s banking and financial sector 6the bottom linerisky investment ventures and a lack of oversight led to major losses failing banks and bailouts during the financial crisis which in turn led to a years long recession in many countries that s why ring fencing was introduced in countries like the united kingdom in countries that require ring fencing it aims to protect the core retail function of banks which is deemed an essential part of the financial industry it also helps shield taxpayers from the heavy burden of having to bail out banks in the event of an economic crisis | |
ripple is a blockchain based digital payment company that has created a network and protocol that uses the cryptocurrency xrp and the xrp ledger ripple s main focus is as a payment settlement asset exchange and remittance system similar to the swift system for international money and security transfers used by banks and financial intermediaries dealing across currencies | ripple s products serve as a sort of temporary global settlement layer for businesses and individuals ripple s industryripple operates in the financial technology industry providing blockchain and cryptocurrency cross border payment crypto liquidity and central bank digital currency services its platforms use the xrp ledger and its native token xrp in its services ripple is unique in this industry as it created the first financial services platform and network that accesses and uses blockchain and cryptocurrency for enterprises it has developed products that provide liquidity and uses cryptocurrency and a bridge currency to speed up international transactions and reduce costs additionally ripple has helped countries create their own central bank digital currencies cbdcs through its ripple cbdc platform ripple s fundraising and financialssince 2012 ripple has had 14 fund raising rounds raising a total of 293 8 million the most recent backers include uday kumar bangalore shivaraman the k fund and azure ventures group 1the company s most recent valuation was over 11 billion which includes a rumored 285 million stock repurchase in 2024 2history and leadershipripple was founded in 2012 by chris larsen david schwartz author britto and jed mccaleb after work began on the xrp ledger its original name was opencoin but it quickly went through a series of name changes until finally becoming ripple founders ripple s current leadership is recent developmentsripple has been expanding its capabilities by acquiring companies involved in cryptocurrency and technology that complements it in 2024 and 2023 it acquired standard custody trust metaco crypto custody services providers these acquisitions will likely help ripple with its plans to offer crypto liquidity services to institutions in addition to institutional decentralized finance solutions in 2020 ripple was sued by the securities and exchange commission the commission alleged the business had sold unregistered securities in its fundraising activities in 2023 judge analisa torres decided that xrp was not a security when sold on exchanges but was a security when sold to institutional investors the sec dropped all charges against chris larsen and brad garlinghouse but continued to insist on fining ripple nearly 2 billion which ripple contested 3did ripple win the lawsuit ripple scored some victories in its defense against the securities and exchange commission but lost regarding the treatment sales of xrp to institutional customers | |
why is ripple banned in the us | ripple is not banned in the u s it is a company that provides blockchain and cryptocurrency services to institutional customers to avoid selling xrp to institutional customers ripple uses xrp in its services outside of the u s but not within it | |
what happens to my xrp if ripple loses the lawsuit | ripple did not lose the lawsuit against the sec but it may face fines because your xrp is not owned or controlled by ripple it will still exist but its market value could fluctuate with the decision about fines the bottom lineripple is a blockchain services and tech company that provides financial services for companies around the world it was started by the same developers who created xrp and the xrp ledger but it does not own the blockchain or develop it ripple is the first business to incorporate blockchain and cryptocurrency into a global enterprise financial network it operates in a new industry so there have been many speed bumps such as regulatory concerns and lawsuits the comments opinions and analyses expressed on investopedia are for informational purposes online read our warranty and liability disclaimer for more info | |
ripple is a blockchain based digital payment company that has created a network and protocol that uses the cryptocurrency xrp and the xrp ledger ripple s main focus is as a payment settlement asset exchange and remittance system similar to the swift system for international money and security transfers used by banks and financial intermediaries dealing across currencies | ripple s products serve as a sort of temporary global settlement layer for businesses and individuals ripple s industryripple operates in the financial technology industry providing blockchain and cryptocurrency cross border payment crypto liquidity and central bank digital currency services its platforms use the xrp ledger and its native token xrp in its services ripple is unique in this industry as it created the first financial services platform and network that accesses and uses blockchain and cryptocurrency for enterprises it has developed products that provide liquidity and uses cryptocurrency and a bridge currency to speed up international transactions and reduce costs additionally ripple has helped countries create their own central bank digital currencies cbdcs through its ripple cbdc platform ripple s fundraising and financialssince 2012 ripple has had 14 fund raising rounds raising a total of 293 8 million the most recent backers include uday kumar bangalore shivaraman the k fund and azure ventures group 1the company s most recent valuation was over 11 billion which includes a rumored 285 million stock repurchase in 2024 2history and leadershipripple was founded in 2012 by chris larsen david schwartz author britto and jed mccaleb after work began on the xrp ledger its original name was opencoin but it quickly went through a series of name changes until finally becoming ripple founders ripple s current leadership is recent developmentsripple has been expanding its capabilities by acquiring companies involved in cryptocurrency and technology that complements it in 2024 and 2023 it acquired standard custody trust metaco crypto custody services providers these acquisitions will likely help ripple with its plans to offer crypto liquidity services to institutions in addition to institutional decentralized finance solutions in 2020 ripple was sued by the securities and exchange commission the commission alleged the business had sold unregistered securities in its fundraising activities in 2023 judge analisa torres decided that xrp was not a security when sold on exchanges but was a security when sold to institutional investors the sec dropped all charges against chris larsen and brad garlinghouse but continued to insist on fining ripple nearly 2 billion which ripple contested 3did ripple win the lawsuit ripple scored some victories in its defense against the securities and exchange commission but lost regarding the treatment sales of xrp to institutional customers | |
why is ripple banned in the us | ripple is not banned in the u s it is a company that provides blockchain and cryptocurrency services to institutional customers to avoid selling xrp to institutional customers ripple uses xrp in its services outside of the u s but not within it | |
what happens to my xrp if ripple loses the lawsuit | ripple did not lose the lawsuit against the sec but it may face fines because your xrp is not owned or controlled by ripple it will still exist but its market value could fluctuate with the decision about fines the bottom lineripple is a blockchain services and tech company that provides financial services for companies around the world it was started by the same developers who created xrp and the xrp ledger but it does not own the blockchain or develop it ripple is the first business to incorporate blockchain and cryptocurrency into a global enterprise financial network it operates in a new industry so there have been many speed bumps such as regulatory concerns and lawsuits the comments opinions and analyses expressed on investopedia are for informational purposes online read our warranty and liability disclaimer for more info | |
what is risk | risk is defined in financial terms as the chance that an outcome or investment s actual gains will differ from an expected outcome or return risk includes the possibility of losing some or all of an original investment 1quantifiably risk is usually assessed by considering historical behaviors and outcomes in finance standard deviation is a common metric associated with risk standard deviation provides a measure of the volatility of asset prices in comparison to their historical averages in a given time frame overall it is possible and prudent to manage investing risks by understanding the basics of risk and how it is measured learning the risks that can apply to different scenarios and some of the ways to manage them holistically will help all types of investors and business managers to avoid unnecessary and costly losses the basics of riskeveryone is exposed to some type of risk every day whether it s from driving walking down the street investing capital planning or something else an investor s personality lifestyle and age are some of the top factors to consider for individual investment management and risk purposes each investor has a unique risk profile that determines their willingness and ability to withstand risk in general as investment risks rise investors expect higher returns to compensate for taking those risks 2a fundamental idea in finance is the relationship between risk and return the greater the amount of risk an investor is willing to take the greater the potential return risks can come in various ways and investors need to be compensated for taking on additional risk for example a u s treasury bond is considered one of the safest investments and when compared to a corporate bond provides a lower rate of return a corporation is much more likely to go bankrupt than the u s government because the default risk of investing in a corporate bond is higher investors are offered a higher rate of return 3quantifiably the risk is usually assessed by considering historical behaviors and outcomes in finance standard deviation is a common metric associated with risk standard deviation provides a measure of the volatility of a value in comparison to its historical average a high standard deviation indicates a lot of value volatility and therefore a high degree of risk individuals financial advisors and companies can all develop risk management strategies to help manage risks associated with their investments and business activities academically there are several theories metrics and strategies that have been identified to measure analyze and manage risks some of these include standard deviation beta value at risk var and the capital asset pricing model capm measuring and quantifying risk often allow investors traders and business managers to hedge some risks away by using various strategies including diversification and derivative positions riskless securitieswhile it is true that no investment is fully free of all possible risks certain securities have so little practical risk that they are considered risk free or riskless riskless securities often form a baseline for analyzing and measuring risk these types of investments offer an expected rate of return with very little or no risk oftentimes all types of investors will look to these securities for preserving emergency savings or for holding assets that need to be immediately accessible examples of riskless investments and securities include certificates of deposits cds government money market accounts and u s treasury bills the 30 day u s treasury bill is generally viewed as the baseline risk free security for financial modeling it is backed by the full faith and credit of the u s government and given its relatively short maturity date has minimal interest rate exposure 456while savings accounts and cds are riskless in the sense that their value cannot go down bank failures can result in losses the fdic only insures up to 250 000 per depositor per bank so any amount above that limit is exposed to the risk of bank failure while u s government bonds are often cited as riskless investors can lose money if the government defaults on its debt the u s came close to defaulting on its debt in 2011 when a political standoff over the debt ceiling led to a downgrade of its credit rating by standard poor s the episode caused significant volatility and uncertainty in financial markets and reduced economic growth 7a looming default in 2023 would likely be worse given the higher level of overall debt and the more polarized political environment 8risk and time horizonstime horizon and liquidity of investments is often a key factor influencing risk assessment and risk management if an investor needs funds to be immediately accessible they are less likely to invest in high risk investments or investments that cannot be immediately liquidated and more likely to place their money in riskless securities time horizons will also be an important factor for individual investment portfolios younger investors with longer time horizons to retirement may be willing to invest in higher risk investments with higher potential returns older investors would have a different risk tolerance since they will need funds to be more readily available 9types of financial riskevery saving and investment action involves different risks and returns in general financial theory classifies investment risks affecting asset values into two categories systematic risk and unsystematic risk broadly speaking investors are exposed to both systematic and unsystematic risks systematic risks also known as market risks are risks that can affect an entire economic market overall or a large percentage of the total market market risk is the risk of losing investments due to factors such as political risk and macroeconomic risk that affect the performance of the overall market market risk cannot be easily mitigated through portfolio diversification other common types of systematic risk can include interest rate risk inflation risk currency risk liquidity risk country risk and sociopolitical risk 10unsystematic risk also known as specific risk or idiosyncratic risk is a category of risk that only affects an industry or a particular company unsystematic risk is the risk of losing an investment due to company or industry specific hazard examples include a change in management a product recall a regulatory change that could drive down company sales and a new competitor in the marketplace with the potential to take away market share from a company 10 investors often use diversification to manage unsystematic risk by investing in a variety of assets 1in addition to the broad systematic and unsystematic risks there are several specific types of risk including business risk refers to the basic viability of a business the question of whether a company will be able to make sufficient sales and generate sufficient revenues to cover its operational expenses and turn a profit while financial risk is concerned with the costs of financing business risk is concerned with all the other expenses a business must cover to remain operational and functioning 10 these expenses include salaries production costs facility rent office and administrative expenses the level of a company s business risk is influenced by factors such as the cost of goods profit margins competition and the overall level of demand for the products or services that it sells operational risk is a type of business risk that arises from the day to day operation of a business and can include risks associated with system failures human errors fraud or other internal processes that might negatively impact a business s financial performance operational risks can be managed through effective internal controls processes and systems businesses and investments can also be exposed to legal risks stemming from changes in laws regulations or legal disputes legal and regulatory risks can be managed through compliance programs monitoring changes in regulations and seeking legal advice as needed credit risk is the risk that a borrower will be unable to pay the contractual interest or principal on its debt obligations 10 this type of risk is particularly concerning to investors who hold bonds in their portfolios government bonds especially those issued by the federal government have the least amount of default risk and as such the lowest returns corporate bonds on the other hand tend to have the highest amount of default risk but also higher interest rates bonds with a lower chance of default are considered investment grade while bonds with higher chances are considered high yield or junk bonds investors can use bond rating agencies such as standard and poor s fitch and moody s to determine which bonds are investment grade and which are junk 3country risk refers to the risk that a country won t be able to honor its financial commitments 10 when a country defaults on its obligations it can harm the performance of all other financial instruments in that country as well as other countries it has relations with country risk applies to stocks bonds mutual funds options and futures that are issued within a particular country this type of risk is most often seen in emerging markets or countries that have a severe deficit | |
when investing in foreign countries it s important to consider the fact that currency exchange rates can change the price of the asset as well foreign exchange risk or exchange rate risk applies to all financial instruments that are in a currency other than your domestic currency 10 | as an example if you live in the u s and invest in a canadian stock in canadian dollars even if the share value appreciates you may lose money if the canadian dollar depreciates in relation to the u s dollar interest rate risk is the risk that an investment s value will change due to a change in the absolute level of interest rates the spread between two rates in the shape of the yield curve or in any other interest rate relationship this type of risk affects the value of bonds more directly than stocks and is a significant risk to all bondholders 10 as interest rates rise bond prices in the secondary market fall and vice versa reinvestment risk is related to interest rate risk it is the possibility that an investor may not be able to reinvest the cash flows received from an investment such as interest or dividends at the same rate of return as the original investment reinvestment risk is particularly relevant for fixed income investments like bonds where interest rates may change over time investors can manage reinvestment risk by laddering their investments diversifying their portfolio or considering investments with different maturity dates political risk is the risk an investment s returns could suffer because of political instability or changes in a country this type of risk can stem from a change in government legislative bodies other foreign policy makers or military control 10 also known as geopolitical risk the risk becomes more of a factor as an investment s time horizon gets longer counterparty risk is the likelihood or probability that one of those involved in a transaction might default on its contractual obligation counterparty risk can exist in credit investment and trading transactions especially for those occurring in over the counter otc markets financial investment products such as stocks options bonds and derivatives carry counterparty risk 11liquidity risk is associated with an investor s ability to transact their investment for cash 10 typically investors will require some premium for illiquid assets which compensates them for holding securities over time that cannot be easily liquidated this type of risk arises from the use of financial models to make investment decisions evaluate risks or price financial instruments model risk can occur if the model is based on incorrect assumptions data or methodologies leading to inaccurate predictions and potentially adverse financial consequences model risk can be managed by validating and periodically reviewing financial models as well as using multiple models to cross check predictions and outcomes risk vs rewardthe risk return tradeoff is the balance between the desire for the lowest possible risk and the highest possible returns in general low levels of risk are associated with low potential returns and high levels of risk are associated with high potential returns 1 each investor must decide how much risk they re willing and able to accept for a desired return this will be based on factors such as age income investment goals liquidity needs time horizon and personality the following chart shows a visual representation of the risk return tradeoff for investing where a higher standard deviation means a higher level or risk as well as a higher potential return it s important to keep in mind that higher risk doesn t automatically equate to higher returns the risk return tradeoff only indicates that higher risk investments have the possibility of higher returns but there are no guarantees on the lower risk side of the spectrum is the risk free rate of return the theoretical rate of return of an investment with zero risk it represents the interest you would expect from an absolutely risk free investment over a specific period of time in theory the risk free rate of return is the minimum return you would expect for any investment because you wouldn t accept additional risk unless the potential rate of return is greater than the risk free rate risk and diversificationthe most basic and effective strategy for minimizing risk is diversification diversification is based heavily on the concepts of correlation and risk 12 a well diversified portfolio will consist of different types of securities from diverse industries that have varying degrees of risk and correlation with each other s returns while most investment professionals agree that diversification can t guarantee against a loss it is the most important component to helping an investor reach long range financial goals while minimizing risk there are several ways to plan for and ensure adequate diversification including keep in mind that portfolio diversification is not a one time task investors and businesses perform regular check ups or rebalancing to make sure their portfolios have a risk level that s consistent with their financial strategy and goals 9can portfolio diversification protect against risks portfolio diversification is an effective strategy used to manage unsystematic risks risks specific to individual companies or industries however it cannot protect against systematic risks risks that affect the entire market or a large portion of it systematic risks such as interest rate risk inflation risk and currency risk cannot be eliminated through diversification alone however investors can still mitigate the impact of these risks by considering other strategies like hedging investing in assets that are less correlated with the systematic risks or adjusting the investment time horizon | |
how does investor psychology impact risk taking and investment decisions | investor psychology plays a significant role in risk taking and investment decisions individual investors perception of risk personal experiences cognitive biases and emotional reactions can influence their investment choices for instance behavioral economics identifies loss aversion a cognitive bias where people are more sensitive to potential losses than gains can make investors overly cautious and avoid riskier investments that might offer higher potential returns understanding one s own psychological tendencies and biases can help investors make more informed and rational decisions about their risk tolerance and investment strategies | |
how do black swan events relate to risk management and how can investors prepare for them | black swan events are rare unpredictable and high impact occurrences that can have significant consequences on financial markets and investments due to their unexpected nature traditional risk management models and strategies may not adequately account for these events to prepare for black swan events investors must understand their bias that things will remain the same and consider implementing stress testing scenario analysis or other techniques that focus on assessing the portfolio s resilience under extreme market conditions additionally maintaining a well diversified portfolio holding adequate cash reserves and being adaptable to evolving market conditions can help investors better navigate the potential fallout from black swan events the bottom linewe all face risks every day whether we re driving to work surfing a 60 foot wave investing or managing a business in the financial world risk refers to the chance that an investment s actual return will differ from what is expected the possibility that an investment won t do as well as you d like or that you ll end up losing money the most effective way to manage investing risk is through regular risk assessment and diversification although diversification won t ensure gains or guarantee against losses it does provide the potential to improve returns based on your goals and target level of risk finding the right balance between risk and return helps investors and business managers achieve their financial goals through investments that they can be most comfortable with | |
what is a risk adjusted return | a risk adjusted return is a calculation of the profit or potential profit from an investment that considers the degree of risk that must be accepted to achieve it the risk is measured in comparison to that of a virtually risk free investment usually u s treasuries depending on the method used the risk calculation is expressed as a number or a rating risk adjusted returns are applied to individual stocks investment funds and entire portfolios understanding risk adjusted returnthe risk adjusted return measures the profit your investment has made relative to the amount of risk the investment has represented throughout a period if two or more investments delivered the same return over a given time the one with the lowest risk will have a better risk adjusted return analysts can use a mar ratio to compare the performance of trading strategies hedge funds and even trading advisors some common risk measures used in investing include alpha beta r squared standard deviation and the sharpe ratio when comparing two or more potential investments you should apply the same risk measure to each investment under consideration to get a relative performance perspective different risk measurements give investors very different analytical results so it is important to be clear on what type of risk adjusted return is being considered examples of risk adjusted return methodshere is a breakdown of the most commonly used measurements the sharpe ratio measures the profit of an investment that exceeds the risk free rate per unit of standard deviation it is calculated by taking the return of the investment subtracting the risk free rate and dividing this result by the investment s standard deviation all else equal a higher sharpe ratio is better the risk free rate used is the yield on very low risk investment usually the 10 year treasury bond t bond for the relevant period for example say mutual fund a returned 12 over the past year and had a standard deviation of 10 mutual fund b returned 10 with a standard deviation of 7 and the risk free rate over the period was 3 the sharpe ratios would be calculated as follows even though mutual fund a had a higher return mutual fund b had a higher risk adjusted return meaning that it gained more per unit of total risk than mutual fund a the treynor ratio is calculated the same way as the sharpe ratio but uses the investment s beta in the denominator as with the sharpe a higher treynor ratio is better using the previous fund example and assuming that each of the funds has a beta of 0 75 the calculations are as follows here mutual fund a has a higher treynor ratio meaning the fund earns more return per unit of systematic risk than fund b here are some of the other popular risk adjustments special considerationsrisk avoidance is not always a good thing in investing so be wary of overreacting to these numbers especially if the measured timeline is short in strong markets a mutual fund with a lower risk than its benchmark can limit the real performance that the investor wants to see a fund that entertains more risk than its benchmark may experience better returns in fact it is common knowledge that higher risk mutual funds may accrue greater losses during volatile periods but they are also likely to outperform their benchmarks over full market cycles | |
what are the 4 risk adjusted return measures | the sharpe ratio alpha beta and standard deviation are the most popular ways to measure risk adjusted returns | |
is risk adjusted return the sharpe ratio | the sharpe ratio is one of several ways to measure an asset s risk adjusted return | |
what is the risk adjusted return on real estate | the popular measurements can be used to evaluate real estate risk and returns if you have the information for the sharpe ratio you d need to know the property s average return and standard deviation using the 10 year treasury rate you could determine the property s risk adjusted return the bottom linerisk adjusted return metrics are used by analysts to find out how much risk an asset has vs a known low risk investment the 10 year treasury is usually used as the risk free rate and various measurements are used to analyze risk none of them are better than the other but some are preferred over others | |
what is risk adjusted return on capital raroc | risk adjusted return on capital raroc is a modified return on investment roi figure that takes elements of risk into account in financial analysis projects and investments with greater risk levels must be evaluated differently raroc thus accounts for changes in an investment s profile by discounting risky cash flows against less risky cash flows the formula for raroc is r a r o c r e e l i f c c where raroc risk adjusted return on capital r revenue e expenses e l expected loss which equals average loss e l expected over a specified period of time i f c income from capital which equals i f c capital charges the risk free rate begin aligned raroc frac r e el ifc c textbf where text raroc text risk adjusted return on capital r text revenue e text expenses el text expected loss which equals average loss phantom el text expected over a specified period of time ifc text income from capital which equals phantom ifc text capital charges times text the risk free rate c text capital end aligned raroc cr e el ifc where raroc risk adjusted return on capitalr revenuee expensesel expected loss which equals average lossel expected over a specified period of timeifc income from capital which equalsifc capital charges the risk free rate understanding risk adjusted return on capitalrisk adjusted return on capital is a useful tool in assessing potential acquisitions the general underlying assumption of raroc is investments or projects with higher levels of risk offer substantially higher returns companies that need to compare two or more different projects or investments must keep this in mind raroc and bankers trustraroc is also referred to as a profitability measurement framework based on risk that allows analysts to examine a company s financial performance and establish a steady view of profitability across business sectors and industries the raroc metric was developed during the late 1970s by bankers trust more specifically dan borge its principal designer the tool grew in popularity through the 1980s serving as a newly developed adjustment to simple return on capital roc a commercial bank at the time bankers trust adopted a business model similar to that of an investment bank bankers trust had unloaded its retail lending and deposit businesses and dealt actively in exempt securities with a derivative business beginning to take root these wholesale activities facilitated the development of the raroc model nationwide publicity led a number of other banks to develop their own raroc systems the banks gave their systems different names essentially lingo used to indicate the same type of metric other methods include return on risk adjusted capital rorac and risk adjusted return on risk adjusted capital rarorac the most commonly used is still raroc non banking firms utilize raroc as a metric for the effect that operational market and credit risk have on finances return on risk adjusted capitalnot to be confused with raroc the return on risk adjusted capital rorac is used in financial analysis to calculate a rate of return where projects and investments with higher levels of risk are evaluated based on the amount of capital at risk more and more companies are using rorac as a greater amount of emphasis is placed on risk management throughout a company the calculation for this metric is similar to raroc with the major difference being capital is adjusted for risk with raroc instead of the rate of return | |
what is risk analysis | the term risk analysis refers to the assessment process that identifies the potential for any adverse events that may negatively affect organizations and the environment risk analysis is commonly performed by corporations banks construction groups health care etc governments and nonprofits conducting a risk analysis can help organizations determine whether they should undertake a project or approve a financial application and what actions they may need to take to protect their interests this type of analysis facilitates a balance between risks and risk reduction risk analysts often work in with forecasting professionals to minimize future negative unforeseen effects understanding risk analysisrisk assessment enables corporations governments and investors to assess the probability that an adverse event might negatively impact a business economy project or investment assessing risk is essential for determining how worthwhile a specific project or investment is and the best process es to mitigate those risks risk analysis provides different approaches that can be used to assess the risk and reward tradeoff of a potential investment opportunity a risk analyst starts by identifying what could potentially go wrong these negatives must be weighed against a probability metric that measures the likelihood of the event occurring finally risk analysis attempts to estimate the extent of the impact that will be made if the event happens many risks that are identified such as market risk credit risk currency risk and so on can be reduced through hedging or by purchasing insurance almost all sorts of large businesses require a minimum sort of risk analysis for example commercial banks need to properly hedge foreign exchange exposure of overseas loans while large department stores must factor in the possibility of reduced revenues due to a global recession it is important to know that risk analysis allows professionals to identify and mitigate risks but not avoid them completely types of risk analysismany people are aware of a cost benefit analysis in this type of analysis an analyst compares the benefits a company receives to the financial and non financial expenses related to the benefits the potential benefits may cause other new types of potential expenses to occur in a similar manner a risk benefit analysis compares potential benefits with associated potential risks benefits may be ranked and evaluated based on their likelihood of success or the projected impact the benefits may have a needs risk analysis is an analysis of the current state of a company often a company will undergo a needs assessment to better understand a need or gap that is already known alternatively a needs assessment may be done if management is not aware of gaps or deficiencies this analysis lets the company know where they need to spending more resources in in many cases a business may see a potential risk looming and wants to know how the situation may impact the business for example consider the probability of a concrete worker strike to a real estate developer the real estate developer may perform a business impact analysis to understand how each additional day of the delay may impact their operations opposite of a needs analysis a root cause analysis is performed because something is happening that shouldn t be this type of risk analysis strives to identify and eliminate processes that cause issues whereas other types of risk analysis often forecast what needs to be done or what could be getting done a root cause analysis aims to identify the impact of things that have already happened or continue to happen | |
how to perform a risk analysis | though there are different types of risk analysis many have overlapping steps and objectives each company may also choose to add or change the steps below but these six steps outline the most common process of performing a risk analysis the first step in many types of risk analysis to is to make a list of potential risks you may encounter these may be internal threats that arise from within a company though most risks will be external that occur from outside forces it is important to incorporate many different members of a company for this brainstorming session as different departments may have different perspectives and inputs a company may have already addressed the major risks of the company through a swot analysis although a swot analysis may prove to be a launching point for further discussion risk analysis often addresses a specific question while swot analysis are often broader some risks may be listed on both but a risk analysis should be more specific when trying to address a specific problem the primary concern of risk analysis is to identify troublesome areas for a company most often the riskiest aspects may be the areas that are undefined therefore a critical aspect of risk analysis is to understand how each potential risk has uncertainty and to quantify the range of risk that uncertainty may hold consider the example of a product recall of defective products after they have been shipped a company may not know how many units were defective so it may project different scenarios where either a partial or full product recall is performed the company may also run various scenarios on how to resolve the issue with customers i e a low medium or high engagement solution most often the goal of a risk analysis is to better understand how risk will financially impact a company this is usually calculated as the risk value which is the probability of an event happening multiplied by the cost of the event for example in the example above the company may assess that there is a 1 chance a product defection occurs if the event were to occur it would cost the company 100 million in this example the risk value of the defective product would be assigned 1 million the important piece to remember here is management s ability to prioritize avoiding potentially devastating results for example if the company above only yielded 40 million of sales each year a single defect product that could ruin brand image and customer trust may put the company out of business even though this example led to a risk value of only 1 million the company may choose to prioritize addressing this due to the higher stakes nature of the risk the inputs from above are often fed into an analysis model the analysis model will take all available pieces of data and information and the model will attempt to yield different outcomes probabilities and financial projections of what may occur in more advanced situations scenario analysis or simulations can determine an average outcome value that can be used to quantify the average instance of an event occurring with the model run and the data available to be reviewed it s time to analyze the results management often takes the information and determines the best course of action by comparing the likelihood of risk projected financial impact and model simulations management may also request to see different scenarios run for different risks based on different variables or inputs after management has digested the information it is time to put a plan in action sometimes the plan is to do nothing in risk acceptance strategies a company has decided it will not change course as it makes most financial sense to simply live with the risk of something happening and dealing with it after it occurs in other cases management may want to reduce or eliminate the risk implementing solutions does not necessarily mean risk avoidance a company can decide to simply live with the current risks it faces other potential solutions may include buying insurance divesting from a product restricting trade in certain geographical regions or sharing operational risk with a partner company qualitative vs quantitative risk analysisunder quantitative risk analysis a risk model is built using simulation or deterministic statistics to assign numerical values to risk inputs that are mostly assumptions and random variables are fed into a risk model for any given range of input the model generates a range of output or outcome the model s output is analyzed using graphs scenario analysis and or sensitivity analysis by risk managers to make decisions to mitigate and deal with the risks a monte carlo simulation can be used to generate a range of possible outcomes of a decision made or action taken the simulation is a quantitative technique that calculates results for the random input variables repeatedly using a different set of input values each time the resulting outcome from each input is recorded and the final result of the model is a probability distribution of all possible outcomes the outcomes can be summarized on a distribution graph showing some measures of central tendency such as the mean and median and assessing the variability of the data through standard deviation and variance the outcomes can also be assessed using risk management tools such as scenario analysis and sensitivity tables a scenario analysis shows the best middle and worst outcome of any event separating the different outcomes from best to worst provides a reasonable spread of insight for a risk manager for example an american company that operates on a global scale might want to know how its bottom line would fare if the exchange rate of select countries strengthens a sensitivity table shows how outcomes vary when one or more random variables or assumptions are changed elsewhere a portfolio manager might use a sensitivity table to assess how changes to the different values of each security in a portfolio will impact the variance of the portfolio other types of risk management tools include decision trees and break even analysis qualitative risk analysis is an analytical method that does not identify and evaluate risks with numerical and quantitative ratings qualitative analysis involves a written definition of the uncertainties an evaluation of the extent of the impact if the risk ensues and countermeasure plans in the case of a negative event occurring examples of qualitative risk tools include swot analysis cause and effect diagrams decision matrix game theory etc a firm that wants to measure the impact of a security breach on its servers may use a qualitative risk technique to help prepare it for any lost income that may occur from a data breach while most investors are concerned about downside risk mathematically the risk is the variance both to the downside and the upside example of risk analysis value at risk var value at risk var is a statistic that measures and quantifies the level of financial risk within a firm portfolio or position over a specific time frame this metric is most commonly used by investment and commercial banks to determine the extent and occurrence ratio of potential losses in their institutional portfolios risk managers use var to measure and control the level of risk exposure one can apply var calculations to specific positions or whole portfolios or to measure firm wide risk exposure var is calculated by shifting historical returns from worst to best with the assumption that returns will be repeated especially where it concerns risk as a historical example let s look at the nasdaq 100 etf which trades under the symbol qqq sometimes called the cubes and which started trading in march of 1999 in january 2000 the etf returned 12 4 but there are points at which the etf resulted in losses as well at its worst the etf ran daily losses of 4 to 8 this period is referred to as the etf s worst 5 based on these historic returns we can assume with 95 certainty that the etf s largest losses won t go beyond 4 so if we invest 100 we can say with 95 certainty that our losses won t go beyond 4 one important thing to keep in mind is that var doesn t provide analysts with absolute certainty instead it s an estimate based on probabilities the probability gets higher if you consider the higher returns and only consider the worst 1 of the returns the nasdaq 100 etf s losses of 7 to 8 represent the worst 1 of its performance we can thus assume with 99 certainty that our worst return won t lose us 7 on our investment we can also say with 99 certainty that a 100 investment will only lose us a maximum of 7 advantages and disadvantages of risk analysisrisk analysis allows companies to make informed decisions and plan for contingencies before bad things happen not all risks may materialize but it is important for a company to understand what may occur so it can at least choose to make plans ahead of time to avoid potential losses risk analysis also helps quantify risk as management may not know the financial impact of something happening in some cases the information may help companies avoid unprofitable projects in other cases the information may help put plans in motion that reduce the likelihood of something happen that would have caused financial stress on a company risk analysis may detect early warning signs of potentially catastrophic events for example risk analysis may identify that customer information is not being adequately secured in this example risk analysis can lead to better processes stronger documentation more robust internal controls and risk mitigation risk is a probabilistic measure and so can never tell you for sure what your precise risk exposure is at a given time only what the distribution of possible losses is likely to be if and when they occur there are also no standard methods for calculating and analyzing risk and even var can have several different ways of approaching the task risk is often assumed to occur using normal distribution probabilities which in reality rarely occur and cannot account for extreme or black swan events the financial crisis of 2008 for example exposed these problems as relatively benign var calculations that greatly understated the potential occurrence of risk events posed by portfolios of subprime mortgages risk magnitude was also underestimated which resulted in extreme leverage ratios within subprime portfolios as a result the underestimations of occurrence and risk magnitude left institutions unable to cover billions of dollars in losses as subprime mortgage values collapsed may aid in minimizing losses due to management preemptively forming a risk planmay allow management to quantify risks and assign dollars to future eventsmay protect company resources produce better processes and mitigate overall riskrelies heavily on estimates so it may be difficult to perform for certain riskscan not predict unpredictable black swan eventsmay underestimate risk magnitude or occurence leading to overconfident operations | |
what is meant by risk analysis | risk analysis is the process of identifying and analyzing potential future events that may adversely impact a company a company performs risk analysis to better understand what may occur the financial implications of that event occurring and what steps it can take to mitigate or eliminate that risk | |
what are the main components of a risk analysis | risk analysis is sometimes broken into three components first risk assessment is the process of identifying what risks are present second risk management is the procedures in place to minimize the damage done by risk third risk communication is the company wide approach to acknowledging and addressing risk these three main components work in tandem to identify mitigate and communicate risk | |
why is risk analysis important | sometimes risk analysis is important because it guides company decision making consider the example of a company considering whether to move forward with a project the decision may be as simple as identifying quantifying and analyzing the risk of the project risk analysis is also important because it can help safeguard company assets whether it be proprietary data physical goods or the well being of employees risk is present everywhere companies must be mindful of where it most likely to occur as well as where it is most likely to have strong negative implications the bottom linerisk analysis is the process of identifying risk understanding uncertainty quantifying the uncertainty running models analyzing results and devising a plan risk analysis may be qualitative or quantitative and there are different types of risk analysis for various situations | |
what is risk assessment | risk assessment is a general term used across many industries to determine the likelihood of loss on an asset loan or investment assessing risk is essential for determining how worthwhile a specific investment is and the best process es to mitigate risk it presents the upside reward compared to the risk profile risk assessment is important in order to determine the rate of return an investor would need to earn to deem an investment worth the potential risk understanding risk assessmentrisk assessment enables corporations governments and investors to assess the probability that an adverse event might negatively impact a business economy project or investment risk analysis provides different approaches investors can use to assess the risk of a potential investment opportunity two types of risk analysis an investor can apply when evaluating an investment are quantitative analysis and qualitative analysis a quantitative analysis of risk focuses on building risk models and simulations that enable the user to assign numerical values to risk an example of quantitative risk analysis would be a monte carlo simulation this method which can be used in a variety of fields such as finance engineering and science runs a number of variables through a mathematical model to discover the different possible outcomes a qualitative analysis of risk is an analytical method that does not rely on numerical or mathematical analysis instead it uses a person s subjective judgment and experience to build a theoretical model of risk for a given scenario a qualitative analysis of a company might include an assessment of the company s management the relationship it has with its vendors and the public s perception of the company investors frequently use qualitative and quantitative analysis in conjunction with one another to provide a clearer picture of a company s potential as an investment another example of a formal risk assessment technique includes conditional value at risk cvar which portfolio managers use to reduce the likelihood of incurring large losses mortgage lenders use loan to value ratios to evaluate the risk of lending funds lenders also use credit analysis to determine the creditworthiness of the borrower risk assessments for investmentsboth institutional and individual investments have expected amounts of risk this is especially true of non guaranteed investments such as stocks bonds mutual funds and exchange traded funds etfs standard deviation is a measure applied to the annual rate of return of an investment to measure the investment s volatility in most cases an investment with high volatility indicates a riskier investment when deciding between several stocks investors will often compare the standard deviation of each stock before making an investment decision however it s important to note that a stock s past volatility or lack thereof does not predict future returns investments that previously experienced low volatility can experience sharp fluctuations particularly during rapidly changing market conditions risk assessments for lendinglenders for personal loans lines of credit and mortgages also conduct risk assessments known as credit checks for example it is common that lenders will not approve borrowers who have credit scores below 600 because lower scores are indicative of poor credit practices a lender s credit analysis of a borrower may consider other factors such as available assets collateral income or cash on hand risk assessments for businessbusiness risks are vast and vary across industries such risks include new competitors entering the market employee theft data breaches product recalls operational strategic and financial risks and natural disaster risks every business should have a risk management process in place to assess its current risk levels and enforce procedures to mitigate the worst possible risks an effective risk management strategy seeks to find a balance between protecting the company from potential risks without hindering growth investors prefer to invest in companies that have a history of good risk management | |
what is risk averse | risk aversion is the tendency to avoid risk the term risk averse describes the investor who chooses the preservation of capital over the potential for a higher than average return in investing risk equals price volatility a volatile investment can make you rich or devour your savings a conservative investment will grow slowly and steadily over time low risk means more stability a low risk investment guarantees a reasonable if unspectacular return with a near zero chance that any of the original investment will be lost generally the return on a low risk investment will match or slightly exceed the level of inflation over time a high risk investment may gain or lose a bundle of money risk averse can be contrasted with risk seeking investopedia michela buttignolunderstanding risk aversethe term risk neutral describes the attitude of an individual who evaluates investment alternatives by focusing solely on potential gains regardless of the risk that may seem counter intuitive to evaluate reward without considering risk seems inherently risky nonetheless offered two investment opportunities the risk neutral investor looks only at the potential gains of each investment and ignores the potential downside risk the risk averse investor will pass up the opportunity for a large gain in favor of safety risk averse investors typically invest their money in savings accounts certificates of deposit cds municipal and corporate bonds and dividend growth stocks all of the above except for municipal and corporate bonds and dividend growth stocks virtually guarantee that the amount invested will still be there whenever the investor chooses to cash it in dividend growth stocks like any stock shares move up or down in value however they are known for two major attributes they are shares of mature companies with proven track records and a steady flow of income and they regularly pay their investors a dividend this dividend can be paid to the investor as an income supplement or reinvested in the company s stock to add to the account s growth over time risk averse investors also are known as conservative investors they are by nature or by circumstances unwilling to accept volatility in their investment portfolios they want their investments to be highly liquid that is that money must be there in full when they re ready to make a withdrawal no waiting for the markets to swing up again the greatest number of risk averse investors can be found among older investors and retirees they may have spent decades building a nest egg now that they are using it or planning on using it soon they are unwilling to risk losses risk averse investment productshigh yield savings account from a bank or credit union provides a stable return with virtually no investment risk the federal deposit insurance corp fdic and the national credit union administration ncua insure funds held in these savings accounts up to generous limits 12the term high yield is relative however the return on the money should meet or slightly exceed the level of inflation risk averse investors who don t need to access their money immediately could place it in a certificate of deposit cds typically pay slightly more than savings accounts but require the investor to deposit the money for a longer period of time early withdrawals are possible but come with penalties that may erase any income from the investment or even bite into the principal a key risk faced by investors in a cd is reinvestment risk this is when interest rates fall and when the cd matures the investor s only option for a cd is at lower rates than before there can also be bank failure risk if the value of the cd is greater than 250 000 cds are particularly useful for risk averse investors who want to diversify the cash portion of their portfolios that is they might deposit some of their cash in a savings account for immediate access and the rest in a longer term account that earns a better return a money market fund is a type of mutual fund that invests in high quality short term debt instruments cash and cash equivalents these funds are very low risk and are structured so that each fund share is always worth 1 00 because they are conservative they tend to pay relatively low rates of interest to investors treasury securities or the debt issued by the u s federal government are considered to be the safest of all securities investors can access treasuries via mutual funds or etfs or directly through the government s treasurydirect website state and local governments as well as corporations also routinely raise money by issuing bonds these debt instruments pay a steady interest income stream to their investors bonds also tend to offer lower risk than stocks note that bonds do come with risks russia defaulted on some of its debts during a financial crisis in 1998 3 the global financial crisis of 2008 2009 was partially caused by the collapse of bonds that were backed by mortgages made to subprime borrowers 4notably the agencies tasked with rating those bonds should have assigned them ratings that reflected the risks of the investments they were junk bonds marketed as safe bonds risk averse investors buy bonds issued by stable governments and healthy corporations their bonds get the highest aaa rating in the worst case bankruptcy scenario bondholders have first dibs on repayment from the proceeds of liquidation municipal bonds have one edge over corporate bonds they are generally exempt from federal and state taxes which enhances the investor s total return dividend growth stocks can appeal to risk averse investors because their predictable dividend payments help offset losses even during a downturn in the stock s price in any case companies that increase their annual dividends each year typically don t show the same volatility as stocks purchased for capital appreciation many of these are stocks in so called defensive sectors that is the companies are steady earners that aren t as severely affected by an overall downturn in the economy examples are companies in the utilities business and companies that sell consumer staples investors generally have the option of reinvesting the dividends to buy more shares of the stock or taking immediate payment of the dividend permanent life insurance products like whole life and universal life come with cash accumulation features tax advantages and living benefits that make them attractive for risk averse investors cash value in a life insurance policy cannot ever lose value and grows over time policy owners can withdraw or borrow against that cash value at any time but this may reduce the policy s death benefit amount risk averse investment strategiesin addition to individual assets or asset classes that cater to risk averse investors there are also a number of risk averse investment strategies that can be employed to minimize losses one way is through diversification of your portfolio diversification means including assets and asset classes that are not highly correlated with one another this way you are not putting all of your eggs into one basket and if some securities fall in a given day others may rise to offset those individual losses mathematically diversification allows you to maximize your expected return while minimizing your overall portfolio risk income investing is another strategy that focuses on holding bonds and other fixed income securities that generate regular cash flows as opposed to seeking capital gains investment income is especially useful for retirees who no longer have employment income and cannot afford to experience losses in the markets income investing does come with certain other risks such as due to inflation or negative credit events bond and cd laddering along with inflation protected securities can help lower your overall fixed income portfolio risk saving is very low risk but it is not investing investing means that your money is inherently at risk whether you are buying a stock or lending money in the form of a bond advantages and disadvantages of being risk averseexhibiting risk aversion means to shy away from risk and in terms of investing means avoiding risky securities risk averse individuals should seek out investments and strategies that fit this low risk tolerance as such one advantage is that the risk of losses are minimized investing in low risk products like fixed income securities can also mean guaranteed cash flows and constant positive returns over time however with low risk comes low expected return in fact the risk return tradeoff does not favor a risk averse investor who shies away from stocks and other risky assets such risk averse investors will tend to enjoy lower total returns especially over long time horizons risk aversion can also lead people to irrationally avoid otherwise good opportunities and may stay away from the markets entirely putting them at a disadvantage when saving for things like retirement moreover money kept idle in savings or under the mattress will lose buying power over time as it is eroded by inflation minimizes risk of lossescan generate steady incomeguaranteed cash flowsmuch lower expected returns especially over timemissed opportunities opportunity cost inflation erodes buying power of savings | |
which types of people are more risk averse | research shows that risk aversion varies among people in general the older you get the lower your risk tolerance is especially as investment time horizons for things like retirement draw near on average lower income individuals and women also tend to be more risk averse than men all else equal 56 | |
is it good to be risk averse | being risk averse is a double edged sword on the one hand you greatly lower your chances of losses but you also can miss good opportunities and greater returns on riskier investments | |
how can i tell if i am a risk averse investor | you can gauge your risk tolerance for investing by taking any number of risk profiling questionnaires available online when you sign up for a brokerage account or financial advising relationship you may also be required to take such an evaluation | |
is risk aversion the same as loss averson | no risk aversion is one s general attitude toward avoiding risk loss aversion is instead the asymmetric propensity to feel the pain of a loss more than the pleasure from an equivalent gain e g losing 100 feels usually worse than gaining 100 feels good being risk averse can be completely rational given one s personal situation loss aversion however is an irrational tendency identified by behavioral economics the bottom linerisk averse investors tend to favor capital preservation over capital gains and seek out more conservative investments than more risk seeking individuals such investments may include savings products cds highly rated bonds and blue chip stocks being risk averse reduces one s chance of experiencing losses but also comes with opportunity costs missing out on good opportunities and sacrificing greater expected returns earned elsewhere | |
what is a risk based capital requirement | risk based capital requirement refers to a rule that establishes minimum regulatory capital for financial institutions risk based capital requirements exist to protect financial firms their investors their clients and the economy as a whole these requirements ensure that each financial institution has enough capital on hand to sustain operating losses while maintaining a safe and efficient market investopedia laura porterunderstanding risk based capital requirementrisk based capital requirements are now subject to a permanent floor as per a rule adopted in june 2011 by the office of the comptroller of the currency occ the board of governors of the federal reserve system and the federal deposit insurance corporation fdic in addition to requiring a permanent floor the rule also provides some flexibility in risk calculation for certain low risk assets the collins amendment of the dodd frank wall street reform and consumer protection act imposes minimum risk based capital requirements for insured depository institutions depository institutions holding firms and non bank financial companies that are supervised by the federal reserve under the dodd frank rules each bank is required to have a total risk based capital ratio of 8 and a tier 1 risk based capital ratio of 4 5 a bank is considered well capitalized if it has a tier 1 ratio of 8 or greater and a total risk based capital ratio of at least 10 and a tier 1 leverage ratio of at least 5 special considerationstypically tier 1 capital includes a financial institution s common stock disclosed reserves retained earnings and certain types of preferred stock total capital includes tier 1 and tier 2 capital and is the difference between a bank s assets and liabilities however there are nuances within both of these categories to set guidelines on how banks should calculate their capital the basel committee on banking supervision which operates through the bank for international settlements publishes the basel accords basel i was introduced in 1988 followed by basel ii in 2004 basel iii was developed in response to deficits in financial regulation that appeared in the late 2000s financial crisis these guidelines are meant to help assess a bank s credit risk related to its balance sheet assets and off balance sheet exposure risk based capital vs fixed capital standardsboth risk based capital and fixed capital standards act as a cushion to protect a company from insolvency however fixed capital standards require all companies to have the same amount of money in their reserves and in contrast risk based capital varies the amount of capital a company must hold based on its level of risk the insurance industry began using risk based capital instead of fixed capital standards in the 1990s after a string of insurance companies became insolvent in the 1980s and 1990s for example in the 1980s under the fixed capital standards two insurers of the same size in the same state were generally required to hold the same amount of capital in reserve but after the 1990s those insurers faced different requirements based on their insurance niche and their unique level of risk | |
what is risk control | risk control is the set of methods by which firms evaluate potential losses and take action to reduce or eliminate such threats it is a technique that utilizes findings from risk assessments which involve identifying potential risk factors in a company s operations such as technical and non technical aspects of the business financial policies and other issues that may affect the well being of the firm risk control also implements proactive changes to reduce risk in these areas risk control thus helps companies limit loss risk control is a key component of a company s enterprise risk management erm protocol | |
how risk control works | modern businesses face a diverse collection of obstacles competitors and potential dangers risk control is a plan based business strategy that aims to identify assess and prepare for any dangers hazards and other potentials for disaster both physical and figurative that may interfere with an organization s operations and objectives the core concepts of risk control include no one risk control technique will be a golden bullet to keep a company free from potential harm in practice these techniques are used in tandem with others to varying degrees and will change as the corporation grows as the economy changes and as the competitive landscape shifts utilizing a risk and control matrix racm for effective risk managementa risk and control matrix racm is a valuable tool used by organizations to better understand and optimize their risk profiles it is a structured approach that helps companies identify assess and manage risks by mapping the relationships between potential risks and the corresponding control measures implemented to mitigate them the racm allows organizations to visualize and evaluate the effectiveness of their risk control strategies and make data driven decisions to enhance their risk management practices the racm typically includes the following components by creating and maintaining an up to date racm organizations can gain a comprehensive understanding of their risk landscape and the effectiveness of their risk control measures this information can inform strategic decision making guide resource allocation and support continuous improvement in risk management practices this rcam example outlines different risk categories such as finance hr operations and it and includes specific risks within each category the likelihood and impact of each risk are assessed leading to an overall risk rating control measures are then listed along with an evaluation of their effectiveness finally action plans are proposed to enhance risk control measures or address identified gaps in risk management keep in mind that this is just a simplified example and an actual racm for an organization would likely be more detailed and cover a broader range of risks and controls examples of risk controlas part of sumitomo electric s risk management efforts the company developed business continuity plans bcps in fiscal 2008 as a means of ensuring that core business activities could continue in the event of a disaster the bcps played a role in responding to issues caused by the great east japan earthquake that occurred in march 2011 because the quake caused massive damage on an unprecedented scale far surpassing the damage assumed in the bcps some areas of the plans did not reach their goals based on lessons learned from the company s response to the earthquake executives continue promoting practical drills and training programs confirming the effectiveness of the plans and improving them as needed 1british petroleum bp has implemented several risk control measures following the deepwater horizon oil spill in 2010 which was one of the largest environmental disasters in history as a result of the spill bp was subject to a 20 8 billion settlement with the u s government and five gulf states in 2015 2 the company has since strengthened its risk management approach to prevent similar incidents in the future 3bp has focused on improving its safety culture including conducting regular safety training and drills for employees investing in advanced technology for better monitoring and control of drilling operations and implementing rigorous safety standards across its global operations the company has also adopted a systematic approach to risk assessment and management which involves identifying evaluating and prioritizing risks and developing tailored risk control strategies to mitigate potential impacts 4moreover bp has increased its efforts to promote transparency and stakeholder engagement the company now publishes an annual sustainability report that provides detailed information on its safety environmental and social performance as well as its progress in implementing risk control measures 5 this openness allows stakeholders to hold the company accountable for its actions and fosters a culture of continuous improvement in risk management starbucks a leading global coffee retailer has implemented various risk control measures to manage its supply chain risks the company sources coffee beans from multiple regions worldwide making it vulnerable to fluctuations in supply and potential disruptions due to weather political instability or other unforeseen events 6to address these risks starbucks has adopted a diversified sourcing strategy which involves procuring coffee beans from a wide range of suppliers across different regions 7 this approach helps the company reduce its reliance on any single supplier or region ensuring a steady supply of raw materials and minimizing the impact of potential disruptions 8furthermore starbucks has established a comprehensive set of supply chain standards known as the coffee and farmer equity c a f e practices these standards cover various aspects of coffee production including quality environmental sustainability and social responsibility by working closely with its suppliers and conducting regular audits starbucks can ensure compliance with these standards thereby minimizing the risk of reputational damage and potential supply chain disruptions 9in addition starbucks uses advanced supply chain management software to monitor its global supply chain in real time enabling the company to identify potential risks early and take appropriate action to mitigate them 10 this proactive approach to risk control has helped starbucks maintain its reputation for high quality coffee and build a resilient sustainable supply chain that supports its continued growth | |
how does risk control differ from risk management | risk control is a subset of risk management while risk management is the overarching process of identifying assessing and prioritizing risks to an organization risk control focuses specifically on implementing strategies to mitigate or eliminate the identified risks risk management typically involves the development of an overall risk management plan whereas risk control addresses the techniques and tactics employed to minimize potential losses and protect the organization can a company eliminate all of its risks through risk control no it is not possible to eliminate all risks completely risk control aims to minimize and manage risks but it cannot remove them entirely some risks are inherent in the business environment or the nature of the industry while others may arise from unforeseen circumstances the goal of risk control is to reduce the likelihood and potential impact of risks on the organization helping to build resilience and maintain stability in the face of uncertainty | |
how can companies identify emerging risks | emerging risks can be challenging to identify as they often involve novel or rapidly changing situations companies can employ various strategies to detect and monitor emerging risks such as | |
how does risk control relate to corporate social responsibility | risk control and corporate social responsibility csr are interconnected in several ways by implementing risk control measures companies can minimize potential harm to stakeholders such as employees customers and the environment this proactive approach to risk management aligns with the principles of csr which emphasize the importance of ethical and sustainable business practices additionally effective risk control can help protect a company s reputation and maintain public trust which are crucial aspects of csr in short risk control is an essential component of a comprehensive csr strategy as it helps companies meet their social environmental and ethical obligations while ensuring long term success and sustainability the bottom linerisk control is a critical part of modern business management enabling companies to identify assess and mitigate potential hazards and threats to their operations and objectives by implementing a combination of risk control techniques such as avoidance loss prevention loss reduction separation duplication and diversification businesses can minimize their exposure to risks and enhance their resilience real world examples such as british petroleum s post deepwater horizon safety measures and starbucks supply chain management strategies demonstrate the importance and effectiveness of robust risk control measures as the business environment continues to evolve companies must remain vigilant and adaptive in their risk control efforts to ensure long term success and sustainability | |
what is a risk free asset | a risk free asset is one that has a certain future return and virtually no possibility of loss debt obligations issued by the u s department of the treasury bonds notes and especially treasury bills are considered to be risk free because the full faith and credit of the u s government backs them because they are so safe the return on risk free assets is very close to the current interest rate many academics say that when it comes to investing nothing can be 100 guaranteed and so there s no such thing as a risk free asset technically this may be correct all financial assets carry some degree of danger the risk they will drop in value or become worthless altogether however the level of risk is so small that for the average investor it is appropriate to consider u s treasurys or any government debt issued by a from stable western nation to be risk free understanding a risk free asset | |
when an investor takes on an investment there is an anticipated return rate expected depending on the duration the asset is held the risk is demonstrated by the fact that the actual return and the anticipated return may be very different since market fluctuations can be hard to predict the unknown aspect of the future return is considered to be the risk generally an increased level of risk indicates a higher chance of large fluctuations which can translate to significant gains or losses depending on the ultimate outcome | risk free investments are considered to be reasonably certain to gain at the level predicted since this gain is essentially known the rate of return is often much lower to reflect the lower amount of risk the expected return and actual return are likely to be about the same while the return on a risk free asset is known this does not guarantee a profit in regards to purchasing power depending on the length of time until maturity inflation can cause the asset to lose purchasing power even if the dollar value has risen as predicted risk free assets and returnsrisk free return is the theoretical return attributed to an investment that provides a guaranteed return with zero risk the risk free rate represents the interest on an investor s money that would be expected from a risk free asset when invested over a specified period of time for example investors commonly use the interest rate on a three month u s t bill as a proxy for the short term risk free rate the risk free return is the rate against which other returns are measured investors that purchase a security with some measure of risk higher than that of a risk free asset like a u s treasury bill will naturally demand a higher level of return because of the greater chance they re taking the difference between the return earned and the risk free return represents the risk premium on the security in other words the return on a risk free asset is added to a risk premium to measure the total expected return on an investment reinvestment riskwhile they re not risky in the sense of being likely to default even risk free assets can have an achilles heel and that s known as reinvestment risk for a long term investment to continue to be risk free any reinvestment necessary must also be risk free and often the exact rate of return may not be predictable from the beginning for the entire duration of the investment for example say a person invests in six month treasury bills twice a year replacing one batch as it matures with another one the risk of achieving each specified returned rate for the six months covering a particular treasury bill s growth is essentially nil however interest rates may change between each instance of reinvestment so the rate of return on the second treasury bill that was purchased as part of the six month reinvestment process may not be equal to the rate on the first treasury bill purchased the third bill may not equal the second s and so on in that regard there is some risk over the long term each individual t bill s return is guaranteed but the rate of return over a decade or however long the investor pursues this strategy is not | |
what is the risk free rate of return | the risk free rate of return is the theoretical rate of return of an investment with zero risk the risk free rate represents the interest an investor would expect from an absolutely risk free investment over a specified period of time the so called real risk free rate can be calculated by subtracting the current inflation rate from the yield of the treasury bond matching your investment duration investopedia ellen lindnerunderstanding the risk free rate of returnin theory the risk free rate is the minimum return an investor expects for any investment investors will not accept additional risk unless the potential rate of return is greater than the risk free rate if you are finding a proxy for the risk free rate of return you must consider the investor s home market negative interest rates can complicate the issue in practice a truly risk free rate does not exist because even the safest investments carry some small amount of risk different countries and economic zones use different benchmarks as their risk free rate the interest rate on a three month u s treasury bill t bill is often used as the risk free rate for u s based investors the three month u s treasury bill is a useful proxy because the market considers there to be virtually no chance of the u s government defaulting on its obligations the large size and deep liquidity of the market contribute to the perception of safety a foreign investor whose assets are not denominated in dollars incurs currency risk when investing in u s treasury bills the risk can be hedged via currency forwards and options but affects the rate of return the short term government bills of other highly rated countries such as germany and switzerland offer a risk free rate proxy for investors with assets in euros eur or swiss francs chf investors based in less highly rated countries that are within the eurozone such as portugal and greece are able to invest in german bonds without incurring currency risk by contrast an investor with assets in russian rubles cannot invest in a highly rated government bond without incurring currency risk importance of risk free ratethe risk free rate serves as a fundamental building block in finance as it has a role in financial modeling investing and valuations as a baseline rate it provides a benchmark against which the return on all other investments is measured in valuation models such as discounted cash flow analysis this is used as the discount rate to determine the present value of future cash flowsthe risk free rate also helps price financial instruments and determine appropriate rates of return for investment strategies for instance it influences the pricing of bonds options and derivatives as it s a key input in pricing models the risk free rate also plays a part in cost of capital calculations it helps companies assess the required return on investment projects and determine their optimal capital structure based on what that company could earn should it choose to not take on any risk last the risk free rate is important to investors by comparing the expected return of an investment to the risk free rate investors can assess whether the potential return justifies the level of risk taken for example if you knew you could earn 5 risk free what amount of risk would you be willing to take on to earn a 7 return would that amount of risk change if you knew you could only earn a risk free rate of 2 risk free rate and financial asset pricingin valuation models such as the capital asset pricing model capm the risk free rate is used as the baseline rate of return against which the expected returns of risky assets are compared according to capm the expected return of an asset is determined by adding a risk premium which compensates investors for bearing additional risk to the risk free rate as a result changes in the risk free rate directly influence the required rate of return for risky assets in bond pricing the risk free rate determines bond yields bonds are priced based on their present value which is calculated by discounting future coupon payments and principal repayment using the prevailing risk free rate when the risk free rate increases the present value of future cash flows decreases leading to a decline in bond prices and an increase in bond yields the opposite is true when the risk free rate decreases the pv of cash flow goes up and so does the bond s price as touched on earlier the risk free rate also influences the pricing of options and other derivatives through models such as the black scholes model the risk free rate is an input in these types of option pricing models and the risk free rate just like with other models affects the value of options by influencing the cost of carrying the underlying asset factors that influence the risk free ratethe risk free rate is complex there are a lot of variables that contribute to what that rate is and the risk free rate is subject to fluctuations very broadly speaking some of the high level factors that influence the risk free rate include proxies for the risk free rateseveral alternatives are commonly used to represent the risk free rate in financial analysis and valuation if you can t seem to get ahold of the risk free rate or need a close alternative some of those proxies include limitations of risk free ratewhile the risk free rate is a real and important concept in financial analysis it has several limitations that investors and analysts should consider the risk free rate assumes risk neutrality meaning it represents the return an investor can earn without taking on any risk however in reality all investments involve some degree of risk even if it s a really really small amount of risk think about how even the largest governments in the world could fail due to uncertain situations the risk free rate is also influenced by various market factors including monetary policy decisions economic conditions and investor sentiment changes in these factors can lead to fluctuations in the risk free rate over time meaning it can be hard to use it as a stable benchmark for long term financial analysis in addition inflation erodes the purchasing power of money over time meaning that the real inflation adjusted risk free rate may be lower than the nominal rate the risk free rate varies across countries and currencies what could be the risk free rate in the united states may be different than the risk free rate in russia this reflects differences in economic conditions monetary policies and geopolitical risk using a single risk free rate for all countries may not properly reflect the riskiness of certain markets or geographical regions last certain proxies for the risk free rate like the ones above may not fully reflect liquidity risk in times of market stress or financial crises liquidity in these markets may dry up this means the price of these goods may dramatically increase and cause the rate of return to substantially decrease meaning there could be some volatility in the risk free rate as well | |
why is the u s 3 month t bill used as the risk free rate | there can never be a truly risk free rate because even the safest investments carry a very small amount of risk however the interest rate on a three month u s treasury bill is often used as the risk free rate for u s based investors this is a useful proxy because the market considers there to be virtually no chance of the u s government defaulting on its obligations the large size and deep liquidity of the market contribute to the perception of safety | |
what are the common sources of risk | risk can manifest itself as absolute risk relative risk and or default risk absolute risk as defined by volatility can be easily quantified by common measures like standard deviation relative risk when applied to investments is usually represented by the relation of price fluctuation of an asset to an index or base since the risk free asset used is so short term it is not applicable to either absolute or relative risk default risk which in this case is the risk that the u s government would default on its debt obligations is the risk that applies when using the 3 month t bill as the risk free rate | |
what are the characteristics of the u s treasury bills t bills | treasury bills t bills are assumed to have zero default risk because they represent and are backed by the good faith of the u s government they are sold at a discount from par at a weekly auction in a competitive bidding process they don t pay traditional interest payments like their cousins the treasury notes and treasury bonds and are sold in various maturities in denominations of 1 000 finally they can be purchased by individuals directly from the government the bottom linethe risk free rate of return is the theoretical rate of return that an investor would expect on an investment with zero risk any investment with a risk level greater than zero must offer a higher rate of return in practice this rate of return doesn t truly exist every investment carries some amount of risk even if that risk is small the three month u s treasury bill is often used as a proxy for a risk free rate of return in u s markets because the risk of default by the government is low other countries and economic zones may use different proxies such as euros or swiss francs | |
what is financial risk management | financial risk management involves identifying the potential downsides in any investment decision and deciding whether to accept the risks or take measures to mitigate them financial risk management is a continuing process as risks can change over time there are risks in all investments successful financial risk management requires a balance between potential risks and potential rewards techniques | |
what are risk measures | risk measures are statistical measures that are historical predictors of investment risk and volatility and they are also major components in modern portfolio theory mpt mpt is a standard financial and academic methodology for assessing the performance of a stock or a stock fund as compared to its benchmark index types of risk measuresthere are five principal risk measures and each measure provides a unique way to assess the risk present in investments that are under consideration the five measures include alpha beta r squared standard deviation and the sharpe ratio risk measures can be used individually or together to perform a risk assessment when comparing two potential investments it is wise to compare similar ones to determine which investment holds the most risk alpha measures risk relative to the market or a selected benchmark index for example if the s p 500 has been deemed the benchmark for a particular fund the activity of the fund would be compared to that experienced by the selected index if the fund outperforms the benchmark it is said to have a positive alpha if the fund falls below the performance of the benchmark it is considered to have a negative alpha beta measures the volatility or systematic risk of a fund in comparison to the market or the selected benchmark index a beta of one indicates the fund is expected to move in conjunction with the benchmark betas below one are considered less volatile than the benchmark while those over one are considered more volatile than the benchmark r squared measures the percentage of an investment s movement attributable to movements in its benchmark index an r squared value represents the correlation between the examined investment and its associated benchmark for example an r squared value of 95 would be considered to have a high correlation while an r squared value of 50 may be considered low the u s treasury bill functions as a benchmark for fixed income securities while the s p 500 index functions as a benchmark for equities standard deviation is a method of measuring data dispersion in regards to the mean value of the dataset and provides a measurement regarding an investment s volatility as it relates to investments the standard deviation measures how much return on investment is deviating from the expected normal or average returns the sharpe ratio measures performance as adjusted by the associated risks this is done by removing the rate of return on a risk free investment such as a u s treasury bond from the experienced rate of return this is then divided by the associated investment s standard deviation and serves as an indicator of whether an investment s return is due to wise investing or due to the assumption of excess risk | |
what are ways to minimize risk with stocks | ways to minimize risk when investing in stocks is to do thorough research before picking a stock diversifying one s portfolio investing alongside one s risk appetite having a long term investment horizon not panicking in terms of volatility and regularly evaluating your portfolio | |
what are the risks with stocks | the primary risk with a stock is that you will lose the money you invested in it the performance of a stock is never guaranteed if you buy a stock the price may never increase but there is always the risk that the price will drop causing you to lose the entire value of your investment | |
what are risk metrics | risk metrics are mathematical approaches to gauging the possible loss of a security or investment portfolio when evaluating stocks risk metrics help investors determine the potential downside the bottom linetrading and investing are difficult picking the right stocks or assets can be complex and it is hard to know the right time to buy a stock and when to sell it there are many metrics out there that can help make a decision particularly those assessing risk utilizing the above metrics can greatly assist investors in making the right investment choices correction april 17 2024 this article has been corrected to state that beta measures systematic risk | |
what is risk neutral | risk neutral is a concept used in both game theory studies and in finance it refers to a mindset where an individual is indifferent to risk when making an investment decision this mindset is not derived from calculation or rational deduction but rather from an emotional preference a person with a risk neutral approach simply doesn t focus on the risk regardless of whether or not that is an ill advised thing to do this mindset is often situational and can be dependent on price or other external factors understanding the concept of risk neutralrisk neutral is a term used to describe the attitude of an individual who may be evaluating investment alternatives if the individual focuses solely on potential gains regardless of the risk they are said to be risk neutral such behavior to evaluate reward without thought to risk may seem to be inherently risky a risk averse investor would not consider the choice to risk a 1000 loss with the possibility of making a 50 gain to be the same as risking only 100 to make the same 50 gain however someone who is risk neutral would given two investment opportunities the risk neutral investor only looks at the potential gains of each investment and ignores the potential downside risk risk neutral pricing and measuresthere could be any number of reasons why an individual would reach a risk neutral mindset but the idea that an individual could actually change from a risk averse mindset to a risk neutral mindset based on pricing changes then leads to another important concept that of risk neutral measures risk neutral measures have extensive application in the pricing of derivatives because the price where investors would be expected to exhibit a risk neutral attitude should be a price of equilibrium between buyers and sellers individual investors are almost always risk averse meaning that they have a mindset where they exhibit more fear over losing money than the amount of eagerness they exhibit over making money this tendency often results in the price of an asset finding a point of equilibrium somewhat below what might be accounted for by the expected future returns on this asset when trying to model and adjust for this effect in marketplace pricing analysts and academics attempt to adjust for this risk aversion by using these theoretical risk neutral measures example of risk neutralfor example consider a scenario where 100 investors are presented and accept the opportunity to gain 100 if they deposit 10 000 in a bank for six months there is virtually no risk of losing money unless the bank itself were in danger of going out of business then suppose those same 100 investors are subsequently presented with an alternative investment this investment gives them the opportunity of gaining 10 000 while accepting the possibility of losing all 10 000 finally suppose we poll the investors over which investment they would choose and give them three responses a i d never consider that alternative b i need more information about the alternative investment c i ll invest in the alternative right now in this scenario those who responded a would be considered risk averse investors and those who responded c would be considered risk seeking investors since the investment value is not accurately determinable with only that much information however those who responded with b recognize that they need more information to determine whether they would be interested in the alternative they are neither adverse to risk nor seeking it for its own sake instead they are interested in the value of expected returns to know whether or not they prefer to take the risk so at the moment they seek more information they are considered risk neutral such investors would probably want to know what the probability of doubling their money might be in comparison to possibly losing it all if the probability of doubling were only 50 then they could recognize that the expected value of that investment is zero since it has an equal possibility of losing everything or doubling if the probability of doubling were to shift to 60 then those who were willing to consider the alternative at that point would have adopted a risk neutral mindset because they were focused on the probability of gain and no longer focused on the risk the price at which risk neutral investors manifest their behavior of considering alternatives despite the risk is an important point of price equilibrium this is a point where the greatest number of buyers and sellers may be present in the market | |
what are risk neutral measures | a risk neutral measure is a probability measure used in mathematical finance to aid in pricing derivatives and other financial assets risk neutral measures give investors a mathematical interpretation of the overall market s risk averseness to a particular asset which must be taken into account in order to estimate the correct price for that asset a risk neutral measure is also known as an equilibrium measure or equivalent martingale measure risk neutral measures explainedrisk neutral measures were developed by financial mathematicians in order to account for the problem of risk aversion in stock bond and derivatives markets modern financial theory says that the current value of an asset should be worth the present value of the expected future returns on that asset this makes intuitive sense but there is one problem with this formulation and that is that investors are risk averse or more afraid to lose money than they are eager to make it this tendency often results in the price of an asset being somewhat below the expected future returns on this asset as a result investors and academics must adjust for this risk aversion risk neutral measures are an attempt at this risk neutral measures and the fundamental theorem of asset pricinga risk neutral measure for a market can be derived using assumptions held by the fundamental theorem of asset pricing a framework in financial mathematics used to study real world financial markets in the fundamental theorem of asset pricing it is assumed that there are never opportunities for arbitrage or an investment that continuously and reliably makes money with no upfront cost to the investor experience says this is a pretty good assumption for a model of actual financial markets though there surely have been exceptions in the history of markets the fundamental theorem of asset pricing also assumes that markets are complete meaning that markets are frictionless and that all actors have perfect information about what they are buying and selling finally it assumes that a price can be derived for every asset these assumptions are much less justified when thinking about real world markets but it is necessary to simplify the world when constructing a model of it only if these assumptions are met can a single risk neutral measure be calculated because the assumption in the fundamental theorem of asset pricing distorts actual conditions in the market it s important not to rely too much on any one calculation in the pricing of assets in a financial portfolio | |
what are risk neutral probabilities | risk neutral probabilities are probabilities of potential future outcomes adjusted for risk which are then used to compute expected asset values in other words assets and securities are bought and sold as if the hypothetical fair single probability for an outcome were a reality even though that is not in fact the actual scenario understanding risk neutral probabilitiesrisk neutral probabilities are used to try to determine objective fair prices for an asset or financial instrument you are assessing the probability with the risk taken out of the equation so it doesn t play a factor in the anticipated outcome by contrast if you tried to estimate the anticipated value of that particular stock based on how likely it is to go up or down considering unique factors or market conditions that influence that specific asset you would be including risk into the equation and thus would be looking at real or physical probability the benefit of this risk neutral pricing approach is that once the risk neutral probabilities are calculated they can be used to price every asset based on its expected payoff these theoretical risk neutral probabilities differ from actual real world probabilities which are sometimes also referred to as physical probabilities if real world probabilities were used the expected values of each security would need to be adjusted for its individual risk profile you might think of this approach as a structured method of guessing what the fair and proper price for a financial asset should be by tracking price trends for other similar assets and then estimating the average to arrive at your best guess for this approach you would try to level out the extreme fluctuations at either end of the spectrum creating a balance that creates a stable level price point you would essentially be minimizing the possible unusual high market outcomes while increasing the possible lows special considerationsrisk neutral is a term that describes an investor s appetite for risk risk neutral investors are not concerned with the risk of an investment however risk averse investors have a greater fear of losing money the term risk neutral can sometimes be misleading because some people may assume it means that the investors are neutral unconcerned or unaware of risk or that the investment itself has no risk or has a risk that can somehow be eliminated however risk neutral doesn t necessarily imply that the investor is unaware of the risk instead it implies the investor understands the risks but it isn t factoring it into their decision at the moment a risk neutral investor prefers to focus on the potential gain of the investment instead when faced with two investment options an investor who is risk neutral would solely consider the gains of each investment while choosing to overlook the risk potential even though they may be aware of the inherent risk implementing risk neutral probability in equations when calculating pricing for fixed income financial instruments is useful this is because you are able to price a security at its trade price when employing the risk neutral measure a key assumption in computing risk neutral probabilities is the absence of arbitrage the concept of risk neutral probabilities is widely used in pricing derivatives |
Subsets and Splits
No community queries yet
The top public SQL queries from the community will appear here once available.