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Risk Management Techniques

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FOREX RISK Foreign exchange risk (also known as exchange raterisk or currency risk) is a financial risk posed by an exposureto unanticipated changes in the exchange rate betweentwo currencies. A common definition of exchange rate risk relates to the effectof unexpected exchange rate changes on the value of the firm In particular, it is defined. Understanding Forex Risk Management The spot forex market is a very leveraged market, in that you could put down a deposit of just $1, to actually trade $, This is a leverage.

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Forex risk management is one of the most debated topics in trading. On one hand, traders want to reduce the size of a potential loss, but on the other hand, such traders also want to benefit by getting the most out of a single trade.

This helps investors evaluate risk numerically. If they believe that they can tolerate the risk, financially and emotionally, they invest. This number reveals what happened for the whole period, but it does not say what happened along the way. This is the difference between the average return and the real return at most given points throughout the year period.

If he can afford the loss, he invests. While that information may be helpful, it does not fully address an investor's risk concerns. The field of behavioral finance has contributed an important element to the risk equation, demonstrating asymmetry between how people view gains and losses.

In the language of prospect theory , an area of behavioral finance introduced by Amos Tversky and Daniel Kahneman in , investors exhibit loss aversion: For more on this, read Behavioral Finance: Often, what investors really want to know is not just how much an asset deviates from its expected outcome, but how bad things look way down on the left-hand tail of the distribution curve. Value at risk VAR attempts to provide an answer to this question.

The idea behind VAR is to quantify how bad a loss on an investment could be with a given level of confidence over a defined period. For example, the following statement would be an example of VAR: Spectacular debacles like that of the hedge fund Long-Term Capital Management in remind us that so-called "outlier events" may occur.

Another risk measure oriented to behavioral tendencies is drawdown , which refers to any period during which an asset's return is negative relative to a previous high mark. In measuring drawdown, we attempt to address three things: One measure for this is beta known as "market risk" , based on the statistical property of covariance.

A beta greater than 1 indicates more risk than the market and vice versa. Beta helps us to understand the concepts of passive and active risk.

The returns are cash-adjusted, so the point at which the x and y-axes intersect is the cash-equivalent return. Drawing a line of best fit through the data points allows us to quantify the passive risk beta and the active risk alpha. The gradient of the line is its beta. For example, a gradient of 1. A manager employing a passive management strategy can attempt to increase the portfolio return by taking on more market risk i.

If the level of market or systematic risk were the only influencing factor, then a portfolio's return would always be equal to the beta-adjusted market return. Of course, this is not the case as returns vary because of a number of factors unrelated to market risk. Investment managers who follow an active strategy take on other risks to achieve excess returns over the market's performance. Active strategies include stock, sector or country selection, fundamental analysis , and charting.

Active managers are on the hunt for alpha, the measure of excess return. In our diagram example above, alpha is the amount of portfolio return not explained by beta, represented as the distance between the intersection of the x and y-axes and the y-axis intercept, which can be positive or negative.

In their quest for excess returns, active managers expose investors to alpha risk, the risk that the result of their bets will prove negative rather than positive. If unexpected economic developments cause energy stocks to sharply decline, the manager will likely underperform the benchmark, an example of alpha risk.

In general, the more active the investment strategy the more alpha a fund manager seeks to generate , the more an investor will need to pay for exposure to that strategy. The difference in pricing between passive and active strategies or beta risk and alpha risk respectively encourages many investors to try and separate these risks e.

This is popularly known as portable alpha , the idea that the alpha component of a total return is separate from the beta component. To the investor, that 1. Portable alpha strategies use derivatives and other tools to refine how they obtain and pay for the alpha and beta components of their exposure. Risk is inseparable from return. Nepradkiten prekybos valiut rinkoje nepasitar su mumis. Mes randame laiko kiekvienam kli….

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