Unrewarded risk: Difference between revisions
imported>Doug Williamson m (Spacing and category added) |
imported>Doug Williamson (Expand based on MCT Reading 4.1.2. Financial Risk Categories 1 March 2012, p13.) |
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So it is never rational - in terms of profit maximisation - to accept an unrewarded risk. | So it is never rational - in terms of profit maximisation - to accept an unrewarded risk. | ||
This can be a very useful way to analyse risks, as it can indicate whether a particular risk is a legitimate business risk (and therefore consistent with the business strategy) or not. | |||
An example of a rewarded risk is a business investment decision, such as an acquisition or the purchase of a new machine, launch of a new product and so on. Such an investment | |||
will be made because there is a reasonable expectation of a return, and hence ultimately an expectation of an increase in shareholder wealth. | |||
Examples of unrewarded risk are operational risks such as the risks of systems failure, fire or theft, all of which may be costly to manage, and for which there is no return for taking. | |||
Clearly risk which is unrewarded is best avoided where there is no cost to doing so. | |||
However, many unrewarded risks, such as fire and theft, are inevitable in business, and must be managed as cost-effectively as possible. | |||
The cost of managing unrewarded risks must be covered by (and thus erodes) the returns earned from rewarded risks. | |||
Revision as of 11:54, 4 September 2014
An unrewarded risk is one which is not associated with any benefit for the party accepting the risk.
So it is never rational - in terms of profit maximisation - to accept an unrewarded risk.
This can be a very useful way to analyse risks, as it can indicate whether a particular risk is a legitimate business risk (and therefore consistent with the business strategy) or not.
An example of a rewarded risk is a business investment decision, such as an acquisition or the purchase of a new machine, launch of a new product and so on. Such an investment will be made because there is a reasonable expectation of a return, and hence ultimately an expectation of an increase in shareholder wealth.
Examples of unrewarded risk are operational risks such as the risks of systems failure, fire or theft, all of which may be costly to manage, and for which there is no return for taking.
Clearly risk which is unrewarded is best avoided where there is no cost to doing so.
However, many unrewarded risks, such as fire and theft, are inevitable in business, and must be managed as cost-effectively as possible.
The cost of managing unrewarded risks must be covered by (and thus erodes) the returns earned from rewarded risks.
