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Portfolio Risk Management & Risk Management Plan

Portfolio Risk Management & Risk Management Plan
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Instructor: Beth Loy

Dr. Loy has a Ph.D. in Resource Economics; master's degrees in economics, human resources, and safety; and has taught masters and doctorate level courses in statistics, research methods, economics, and management.

In this lesson, learn more about portfolio risk management and what defines a portfolio risk. Understand how to maintain a portfolio level risk register and a portfolio management reserve while monitoring governance risk guidelines.

Portfolio Risk Management

Megan is a senior investment analyst who oversees several agency portfolios. She spends most of her day administering the portfolios, transferring funds, rebalancing investments, and communicating with clients. Her specialty is high-risk investments. She is an expert in portfolio risk management.

Portfolio risk management is the collection and analysis of risks across individual portfolio investments, such as stocks, bonds, money market funds, and cash. Risk is the probability that actual investment returns are less than those that are projected. Of course, Megan's goal is to get the highest return on an investment possible. She must be ahead of every other investor when it comes to predicting risk. She needs to make investments that meet her company's strategic goals and objectives and don't waiver from the client's business values. If an investor wants to invest in only environment-friendly ventures, Megan must support it. But she needs to balance these goals and objectives against portfolio risks. Portfolio risks include market risk, interest-rate risk, inflation risk, and credit risk:

  • Market risk is the probability that the value of an investment follows the rise and fall of the stock market. For example, if the stock market is declining, Megan needs to shift her investments to bonds in order to counteract this decline.
  • Interest-rate risk is the risk that the value of an investment will fall as the interest rates rise. For example, if Megan purchases bonds, there is a chance that their worth will decrease with increasing interest rates.
  • Inflation risk is the chance that the value of an investment declines because of the interest rate. For example, if Megan invests in X stock and its growth does not keep up with the rate of inflation, she'd be losing money.
  • Credit risk focuses on whether a bond issuer can repay a bond debt once it matures. For example, if Megan invests in junk bonds, she is taking a chance on higher payoffs with higher risk.

To manage the unpredictability of these risks, Megan keeps portfolio management reserves available. Portfolio management reserves are shares of the portfolio reserved as protection and used to maximize investment returns and ensure that there is enough liquidity available when portfolios need to be restructured. Liquidity is important because it is the ability of an asset to be bought and sold quickly, without affecting the worth of the asset. It is a function of stability. Enough liquidity means that Megan has the ability to quickly rebalance portfolios when the risks get too high.

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