Accepting Risk - Corporate Finance Institute

Accepting risk is a concept where an individual or business identifies risk and renders it acceptable, thereby making no effort to reduce or mitigate it. AcceptingRiskAconceptwhereanindividualorbusinessidentifiesriskandrendersitacceptable,therebymakingnoefforttoreduceormitigateitHome›Resources›Knowledge›Finance›AcceptingRiskWhatisAcceptingRisk?Acceptingriskisaconceptwhereanindividualorbusinessidentifiesriskandrendersitacceptable,therebymakingnoefforttoreduceormitigateit.Thepotentiallossfromtheidentifiedandacceptedriskisconsideredbearable.  TheconceptofriskacceptanceiscommonlyapplicableininvestmentfieldsandbusinessesasariskmanagementRiskManagementRiskmanagementencompassestheidentification,analysis,andresponsetoriskfactorsthatformpartofthelifeofabusiness.Itisusuallydonewithstrategy.Somecompaniescannotinsureagainsttheirrisksifthecostofbearingitiscomparativelylower;henceacceptingriskisalsoknownasriskretention.Riskacceptancebecomesanoptionwhensmallandinfrequentrisksareidentified,andsincetheyarenotcatastrophicorexpensive,noeffortsaremadetomanagethem. Theimpactsofsuchuncertaintiesareusuallydeemedasbearableorotherwisetooexpensiveandare,therefore,acceptedaspartofthesystemanddealtwithastheyoccur.RiskacceptanceisthehallmarkofasuccessfulprioritizationandcontingencybudgetingBudgetingBudgetingisthetacticalimplementationofabusinessplan.Toachievethegoalsinabusiness’sstrategicplan,weneedsometypeofbudgetbecauseofitsreducedoutlayonapremium. SummaryAcceptingriskistheamountoffinancialuncertaintythatanindividualoranenterprisecanretainwithoutoverlyinsuring,hedging,ormitigating.Acceptingriskassumesvariousfinancialandorganizationalapproachesmeanttoprovideafinancialbufferduringriskmaterialization.Whileriskacceptanceoffersanetfinancialreturn,theoptimaldecisiontoitsadoptionreliesonamanager’sperspective,andnotonsystematicthreatsofthemarket. AcceptingRiskExplainedManybusinessenterprisesadoptvariousriskmanagementtechniquestoevaluateandclassifyfinancialdistressprobabilitiesforeasiermonitoringandcontrolling.Managersandstrategistsfindthatbusinessorganizationsfacenumerousbusinessthreatsthatcanbeavoidedormitigatedinrelationtothelevelofgrowthandtheallocatedresources.Asaresult,businessesresorttocontrolactivitiesmeanttostrikeatrade-offbalancebetweenthefinancialimplicationsofanissueemanatingfromanidentifiedandacceptablerisk,aswellasthecostofmanagingit.Sourcesofrisksaremulti-faceted,andtheyincludenaturaldisasters,overlyaggressivecompetition,exchangerates,andunexpectedvariabilityofproductprices,legalobligations,andcreditriskCreditRiskCreditriskistheriskoflossthatmayoccurfromthefailureofanypartytoabidebythetermsandconditionsofanyfinancialcontract,principally,.Acceptingrisk,therefore,carriesthesamesenseasself-insurance.Thechoiceofacceptingriskisgenerallyinrelationtothesmallpotentialfinancialdistressesthatmaterializeeachday.However,businessenterprisesmaysometimesacceptretainingacatastrophicuncertaintywhoseinsurancecostsarenotfinanciallyfeasible.Acceptingriskcantakedifferentfinancialandorganizationalforms,suchascontinuouslycreatingafinancialreserve,usingcaptives,oraccumulatingfinancialresourcesinspecialaccounts.Ininsurancecompanies,acceptingriskcanalsoincludedeductiblesandunderinsurance,aswellasaggregatedeductibleplans.Allthecomponentsrequirecreatingareservefundinaninsurancecompanytocushionthatpartoflossesthatareuninsuredbecauseofthedeductibles.Riskretentionisnotmerelyasimpledecision.Rather,itisanenterprise’sdeliberatedecisiontoacknowledgethatrisksinspecificareaswillbedealtwithastheyarise.Riskfinancingstrategyconsiderstheabilitytoidentifyandestimateperceivedrisks.Acceptingriskcomeswithlimitationsaswell,whicharedeterminedbythecompany’scapacitytoabsorbfinancialconsequencesintheeventofarisk.Itisessentialtomanagersandbusinessstrategistswhentheyaredecidingonriskretentionpolicies. UpsideandDownsideofAcceptingRiskBusinesseswithinsuranceprogramsenjoyanadvantageinminimizingexpectedriskretentioncosts.Theconditionthatcanexplainsuchalineofthoughtisthattheanticipatedvalueoftheloss,inthelongterm,islowerthanthecostofinsuringit.Inpractice,suchaconditionisseenwheninsurancecompaniespaypremiumsthatfaroutweightheactualrisk.Itistruebecausetheriskprofileofanindividualcompanydiffersfromtheaveragevaluesassumedwhencalculatingtheinsurancepremiums.However,oneproblemwithriskacceptanceliesinthesaidoptimalriskretentiondecisionthatreliesonamanager’sperspective,andnotthesystematicprofitsandrisksperceivedbythemarket.Thereasoningthatamanager’sdecisioncannotbeassumedtobeoptimalforthecompanyjustifiestheconcept.Inlightofariskmanagement’spurposetomaximizevaluegrowth,abalancedrelationshipbetweentotalcostsofriskexposureandsavingonpremiumsisnecessaryforriskacceptance.Anypotentialfinanciallossresultingfromanuncoveredriskisalsoanexampleofacceptingrisk. AlternativestoAcceptingRiskWhileacceptingriskisconsideredanappropriatechoiceinmanyscenarios,thereareadditionalapproachestomitigaterisksinriskmanagement: 1.RisktransferRlstransferinvolvesallocatingriskfromonepartytoanotheronacontractualbasis.Theequitableriskallocationensuresthattheresponsibilityforriskisallocatedtothepartyinlinewithitscapabilitytocontrolandinsureagainsttherisk.Themethodiscommonlyusedbyinsurancecompanies. 2.RiskavoidanceRiskavoidanceinvolveseliminatinganyactivitythatposespotentialloss.Itisidealforrisksthatarelikelytocauseasevereimpactonaprojectorbusiness.Managersachieveriskavoidancethroughpolicyandprocedures,implementationoftechnologies,aswellastrainingandeducation. 3.RiskmitigationRiskmitigationinvolveslimitingtheconsequencesofarisktodealwithasitoccurs.ThestrategyiscommonlyachievedthroughhedgingHedgingHedgingisafinancialstrategythatshouldbeunderstoodandusedbyinvestorsbecauseoftheadvantagesitoffers.Asaninvestment,itprotectsanindividual’sfinancesfrombeingexposedtoariskysituationthatmayleadtolossofvalue.. MoreResourcesCFIistheofficialprovideroftheCommercialBanking&CreditAnalyst(CBCA)™ProgramPage-CBCAGetCFI'sCBCA™certificationandbecomeaCommercialBanking&CreditAnalyst.Enrollandadvanceyourcareerwithourcertificationprogramsandcourses.certificationprogram,designedtotransformanyoneintoaworld-classfinancialanalyst.Tokeeplearninganddevelopingyourknowledgeoffinancialanalysis,wehighlyrecommendtheadditionalresourcesbelow:RiskTransferRiskTransferRisktransferreferstoariskmanagementtechniqueinwhichriskistransferredtoathirdparty.Inotherwords,itinvolvesonepartyassumingriskBusinessRiskBusinessRiskBusinessriskreferstoathreattothecompany’sabilitytoachieveitsfinancialgoals.Inbusiness,riskmeansthatacompany'soranorganization'splansRisk-AdjustedReturnRatiosRisk-AdjustedReturnRatiosThereareanumberofrisk-adjustedreturnratiosthathelpinvestorsassessexistingorpotentialinvestments.TheratioscanbemorehelpfulManagingRisksinInvestmentBankingManagingRisksinInvestmentBankingTheideaofmanagingsrisksininvestmentbankingmayseemprettystraightforward,butinordertocoverthetopicfully,let’sstartwithabriefoverviewFinancialAnalystTrainingGetworld-classfinancialtrainingwithCFI’sonlinecertifiedfinancialanalysttrainingprogramBecomeaCertifiedFinancialModeling&ValuationAnalyst(FMVA)®CFI'sFinancialModelingandValuationAnalyst(FMVA)®certificationwillhelpyougaintheconfidenceyouneedinyourfinancecareer.Enrolltoday!!Gaintheconfidenceyouneedtomoveuptheladderinahighpoweredcorporatefinancecareerpath. LearnfinancialmodelingandvaluationExploreAllCoursesinExceltheeasyway,withstep-by-steptraining. CorporateFinanceInstituteBacktoWebsite0searchresultsfor‘’Peoplealsosearchfor:excelFreefreecoursesaccountingBalancesheetDCFIRRExploreOurCertificationsFinancialModeling&ValuationAnalyst(FMVA)®LearnmoreCommercialBanking&CreditAnalyst(CBCA)™LearnmoreCapitalMarkets&SecuritiesAnalyst(CMSA)®LearnmoreCertifiedBusinessIntelligence&DataAnalyst(BIDA)™LearnmoreResourcesExcelShortcutsPCMacListofExcelShortcuts 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