Question

explain in detail the concept of risk and its importance how risk in the valuation of financial instruments

Answer 1

The concept of risk is associated with the fact that every investor has limited capital. When you have limited amount of resources then you would like to use your resources in such a way as to maximize the expected return from them. The risk arises also from the fact the outcomes in the future can be very different then what you have expected and this might erode your capital base. Different investors have different level of risk tolerance and ability to bear risk so they should manage there risk wisely. The importance of risk management in finance and investment is very crucial as markets are very volatile and if effective risk management practices are not used then it can cause large losses to the investors. When investors come with different level of risk tolerance then risk management becomes very important because one financial product might be suitable for one investor but the same product might not be suitable for another investor. Liquidity requirement is also a big reason why risk need to be managed appropriately. Some investor liability requirement is higher and they can not consider asset which are highly volatile or there is not enough liquidity in them because in case they need to liquidate the asset then finding a buyer at fair value would be difficult to do. The risk management is also important from the perspective of the future liability or funds requirement like retirement. Most people when invest they do it so that they can withdraw when they need it and it need to be managed accordingly.