Page 47 - DMGT515_PERSONAL_FINANCIAL_PLANNING

Personal Financial Planning

Notes the land, sows the seeds with an expectation of better yield. Till the crop is ripe and he actually
reaps the harvest, he rarely knows whether his expectations have come true. In between
expectation and reality, there is the interplay of many variables. Continuing the example of the
farmer, there are key variables such as weather, seeds, fertilizers, farm management techniques
that make the expectations turn into reality. There is the possibility of adverse happening in any
of the variables widening the gap between the expectation and reality. The analogy applies
equally to a company, to an investment manager and every individual or institution that is
faced with a decision making situation.

3.1 Meaning and Definitions of Risk

Risk is a concept that denotes a potential negative impact to some characteristic of value that
may arise from a future event. Exposure to the consequences of uncertainty constitutes a risk. In
everyday usage, risk is often used synonymously with the probability of a known loss.
Risk communication and risk perception are essential factors for all human decision making.
There are many definitions of risk that vary by specific application and situational context. Risk
is described both qualitatively and quantitatively. Qualitatively, risk is proportional to both the
expected losses which may be caused by an event and to the probability of this event. Greater
loss and greater event likelihood result in a greater overall risk.

Frequently in the subject matter literature, risk is defined in pseudo-formal forms where the
components of the definition are vague and ill-defined, for example, risk is considered as an
indicator of threat, or depends on threats, vulnerability, impact and uncertainty.
In engineering, the definition of risk is Measuring engineering risk is often difficult, especially
in potentially dangerous industries such as nuclear energy. Often, the probability of a negative
event is estimated by using the frequency of past similar events or by event-tree methods, but
probabilities for rare failures may be difficult to estimate if an event tree cannot be formulated.
Methods to calculate the cost of the loss of human life vary depending on the purpose of the
calculation. Specific methods include what people are willing to pay to insure against death, and
radiological release (e.g., GBq of radio-iodine). There are many formal methods used to assess
or to “measure” risk, considered as one of the critical indicators important for human decision
making.
Financial risk is often defined as the unexpected variability or volatility of returns and thus
includes both potential worse-than-expected as well as better-than-expected returns. References
to negative risk below should be read as applying to positive impacts or opportunity (e.g., for
“loss” read “loss or gain”) unless the context precludes.
In statistics, risk is often mapped to the probability of some event which is seen as undesirable.
Usually, the probability of that event and some assessment of its expected harm must be combined
into a believable scenario (an outcome), which combines the set of risk, regret and reward
probabilities into an expected value for that outcome.
Thus, in statistical decision theory, the risk function of an estimator δ(x) for a parameter θ,
calculated from some observables x, is defined as the expectation value of the loss function L,

In information security, a risk is defined as a function of three variables:
The probability that there is a threat
The probability that there are any vulnerabilities
The potential impact.
If any of these variables approaches zero, the overall risk approaches zero.

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