Risk Management
Expert-defined terms from the Investment Portfolio Analysis course at London School of Business and Administration. Free to read, free to share, paired with a professional course.
Absolute Risk is the possibility that an investment will lose value due t… #
Related terms include Systematic Risk and Unsystematic Risk. Absolute Risk is a key concept in Risk Management, as it helps investors understand the potential losses associated with an investment. For example, an investor who purchases a stock may face Absolute Risk if the company's financial performance declines, leading to a decrease in stock price.
Active Management is an investment approach that involves actively select… #
Related terms include Passive Management and Portfolio Optimization. Active Management involves using various strategies such as stock picking, market timing, and portfolio rebalancing to generate returns that exceed the market average. For instance, an active manager may use technical analysis to identify undervalued stocks and purchase them, with the goal of selling them at a higher price in the future.
Alpha is a measure of an investment's excess return over the market avera… #
Related terms include Beta and Sharpe Ratio. Alpha is a key concept in Risk Management, as it helps investors evaluate the performance of their investments and make informed decisions. For example, an investment with a high Alpha may be considered a good investment, as it has generated returns that exceed the market average.
Arbitrage is the practice of taking advantage of price differences betwee… #
Related terms include Market Efficiency and Risk-Free Rate. Arbitrage is a key concept in Risk Management, as it helps investors understand the relationship between different markets and make informed decisions. For instance, an investor may engage in Arbitrage by purchasing a security at a low price in one market and selling it at a higher price in another market.
Asset Allocation is the process of dividing a portfolio among different a… #
Related terms include Diversification and Portfolio Optimization. Asset Allocation involves allocating assets to different classes such as stocks, bonds, and real estate to minimize risk and maximize returns. For example, an investor may allocate 60% of their portfolio to stocks and 40% to bonds to achieve a balance between risk and return.
Asset Class is a category of investments that exhibit similar characteris… #
Related terms include Asset Allocation and Diversification. Asset Class includes categories such as stocks, bonds, real estate, and commodities. For instance, an investor may invest in a mix of asset classes to diversify their portfolio and manage risk.
Beta is a measure of an investment's volatility relative to the market av… #
Related terms include Alpha and Sharpe Ratio. Beta is a key concept in Risk Management, as it helps investors evaluate the risk of their investments and make informed decisions. For example, an investment with a high Beta may be considered riskier, as it is more volatile than the market average.
Black Swan is an event that is rare, unexpected, and has a significant im… #
Related terms include Risk Management and Uncertainty. Black Swan events are difficult to predict and can have a significant impact on investment portfolios. For instance, the 2008 global financial crisis was a Black Swan event that had a significant impact on investment portfolios.
Capital Asset Pricing Model (CAPM) is a model that describes the relation… #
Related terms include Alpha and Beta. CAPM is a key concept in Risk Management, as it helps investors evaluate the performance of their investments and make informed decisions. For example, an investor may use CAPM to estimate the expected return of an investment based on its Beta.
Compound Interest is the process of earning interest on both the principa… #
Related terms include Time Value of Money and Investment Returns. Compound Interest is a key concept in Risk Management, as it helps investors understand the growth of their investments over time. For instance, an investor who invests $1000 at an interest rate of 5% per annum may earn $1050 in interest over a year, and then earn interest on the new principal amount of $1050 in subsequent years.
Correlation is a measure of the relationship between two or more investme… #
Related terms include Diversification and Portfolio Optimization. Correlation is a key concept in Risk Management, as it helps investors evaluate the risk of their investments and make informed decisions. For example, an investor may use Correlation to identify investments that are negatively correlated, and allocate assets to these investments to minimize risk.
Credit Risk is the risk that a borrower will default on a loan or debt ob… #
Related terms include Default Risk and Credit Score. Credit Risk is a key concept in Risk Management, as it helps investors evaluate the risk of lending to borrowers. For instance, an investor may evaluate the Credit Risk of a borrower by analyzing their credit history and financial performance.
Default Risk is the risk that a borrower will fail to meet their debt obl… #
Related terms include Credit Risk and Credit Score. Default Risk is a key concept in Risk Management, as it helps investors evaluate the risk of lending to borrowers. For example, an investor may evaluate the Default Risk of a borrower by analyzing their credit history and financial performance.
Diversification is the process of spreading investments across different… #
Related terms include Asset Allocation and Portfolio Optimization. Diversification is a key concept in Risk Management, as it helps investors reduce the risk of their investments. For instance, an investor may diversify their portfolio by investing in a mix of stocks, bonds, and real estate to minimize risk.
Efficient Frontier is a concept in portfolio theory that describes the op… #
Related terms include Portfolio Optimization and Risk-Return Tradeoff. Efficient Frontier is a key concept in Risk Management, as it helps investors evaluate the performance of their investments and make informed decisions. For example, an investor may use the Efficient Frontier to identify the optimal portfolio that offers the highest return for a given level of risk.
Efficient Market Hypothesis (EMH) is a theory that states that financial… #
Related terms include Market Efficiency and Random Walk. EMH is a key concept in Risk Management, as it helps investors understand the behavior of financial markets and make informed decisions. For instance, an investor may use EMH to evaluate the performance of their investments and make informed decisions.
Expected Return is the expected return of an investment based on its hist… #
Related terms include Risk-Return Tradeoff and Portfolio Optimization. Expected Return is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For example, an investor may estimate the Expected Return of an investment based on its historical performance and allocate assets accordingly.
Growth Investing is an investment approach that involves investing in com… #
Related terms include Value Investing and Dividend Investing. Growth Investing is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For instance, an investor may invest in a company with high growth potential, such as a technology startup, to generate high returns.
Hedging is the process of reducing or managing risk by taking a position… #
Related terms include Risk Management and Derivatives. Hedging is a key concept in Risk Management, as it helps investors reduce the risk of their investments. For example, an investor may hedge against a potential decline in stock prices by purchasing a put option.
Inflation Risk is the risk that inflation will erode the purchasing power… #
Related terms include Interest Rate Risk and Currency Risk. Inflation Risk is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For instance, an investor may invest in inflation-indexed bonds to protect against Inflation Risk.
Interest Rate Risk is the risk that changes in interest rates will affect… #
Related terms include Inflation Risk and Credit Risk. Interest Rate Risk is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For example, an investor may invest in short-term bonds to reduce Interest Rate Risk.
Investment Horizon is the timeframe over which an investor plans to hold… #
Related terms include Risk Tolerance and Investment Objectives. Investment Horizon is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For instance, an investor with a long-term Investment Horizon may be more willing to take on risk to generate higher returns.
Liquidity Risk is the risk that an investor will be unable to sell an inv… #
Related terms include Market Risk and Credit Risk. Liquidity Risk is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For example, an investor may invest in liquid assets such as stocks or bonds to reduce Liquidity Risk.
Market Efficiency is the theory that financial markets are informationall… #
Related terms include Efficient Market Hypothesis and Random Walk. Market Efficiency is a key concept in Risk Management, as it helps investors understand the behavior of financial markets and make informed decisions. For example, an investor may use Market Efficiency to evaluate the performance of their investments and make informed decisions.
Market Risk is the risk that the value of an investment will decline due… #
Related terms include Systematic Risk and Unsystematic Risk. Market Risk is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For instance, an investor may invest in a diversified portfolio to reduce Market Risk.
Modern Portfolio Theory (MPT) is a framework for constructing portfolios… #
Related terms include Portfolio Optimization and Risk-Return Tradeoff. MPT is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For example, an investor may use MPT to construct a portfolio that maximizes returns for a given level of risk.
Option is a contract that gives the holder the right, but not the obligat… #
Related terms include Derivatives and Hedging. Option is a key concept in Risk Management, as it helps investors reduce the risk of their investments. For instance, an investor may purchase a call option to hedge against a potential increase in stock prices.
Passive Management is an investment approach that involves tracking a mar… #
Related terms include Active Management and Index Fund. Passive Management is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For example, an investor may invest in a passively managed index fund to reduce costs and track the market average.
Portfolio Optimization is the process of constructing a portfolio that ma… #
Related terms include Asset Allocation and Risk-Return Tradeoff. Portfolio Optimization is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For instance, an investor may use Portfolio Optimization to construct a portfolio that maximizes returns for a given level of risk.
Random Walk is a theory that states that stock prices move randomly and u… #
Related terms include Efficient Market Hypothesis and Market Efficiency. Random Walk is a key concept in Risk Management, as it helps investors understand the behavior of financial markets and make informed decisions. For example, an investor may use Random Walk to evaluate the performance of their investments and make informed decisions.
Risk #
Return Tradeoff is the concept that higher returns are associated with higher risk. Related terms include Portfolio Optimization and Efficient Frontier. Risk-Return Tradeoff is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For instance, an investor may invest in a high-risk asset to generate higher returns, but must also be willing to accept the potential for higher losses.
Risk Tolerance is the ability of an investor to withstand potential losse… #
Related terms include Investment Horizon and Risk-Return Tradeoff. Risk Tolerance is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For example, an investor with a high Risk Tolerance may be more willing to take on risk to generate higher returns.
Sharpe Ratio is a measure of an investment's excess return over the risk #
free rate, adjusted for risk. Related terms include Alpha and Beta. Sharpe Ratio is a key concept in Risk Management, as it helps investors evaluate the performance of their investments and make informed decisions. For instance, an investor may use Sharpe Ratio to evaluate the performance of their investments and make informed decisions.
Standard Deviation is a measure of the volatility or dispersion of an inv… #
Related terms include Variance and Volatility. Standard Deviation is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For example, an investor may use Standard Deviation to evaluate the risk of an investment and make informed decisions.
Systematic Risk is the risk that is inherent in the market as a whole and… #
Related terms include Market Risk and Unsystematic Risk. Systematic Risk is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For instance, an investor may invest in a diversified portfolio to reduce Systematic Risk.
Time Value of Money is the concept that a dollar received today is worth… #
Related terms include Present Value and Future Value. Time Value of Money is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For example, an investor may use Time Value of Money to evaluate the present value of a future cash flow and make informed decisions.
Unsystematic Risk is the risk that is specific to a particular company or… #
Related terms include Market Risk and Systematic Risk. Unsystematic Risk is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For instance, an investor may invest in a diversified portfolio to reduce Unsystematic Risk.
Value at Risk (VaR) is a measure of the potential loss of an investment o… #
Related terms include Expected Shortfall and Stress Testing. VaR is a key concept in Risk Management, as it helps investors evaluate the potential losses of their investments and make informed decisions. For example, an investor may use VaR to evaluate the potential loss of an investment and make informed decisions.
Volatility is the measure of the dispersion or variability of an investme… #
Related terms include Standard Deviation and Variance. Volatility is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For instance, an investor may use Volatility to evaluate the risk of an investment and make informed decisions.
Yield is the return on an investment, expressed as a percentage of the in… #
Related terms include Interest Rate and Dividend Yield. Yield is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For example, an investor may invest in a bond with a high Yield to generate income and reduce risk.
Yield Curve is a graph that plots the yield of a bond against its maturit… #
Related terms include Interest Rate and Term Structure. Yield Curve is a key concept in Risk Management, as it helps investors evaluate the potential returns of their investments and make informed decisions. For instance, an investor may use the Yield Curve to evaluate the potential returns of a bond and make informed decisions.