Risk Measures

  

Categories: Managed Funds, Metrics

How risky was it? Yes, you won the lottery, but that million dollar payout over 20 years was a 1-in-a-billion shot, and you were just ungodly lucky. Good risk? No. Luck? Yes.

Risk measures are big pretty much everywhere in everything, but in hedge funds, there's actually a role called Senior Risk Officer, or something like that. This is the person who did something very bad in a former life and now must be punished by having to have this job. All day long, like Sisyphus, he pushes a risk rock up a hill, making financial what-if models. If a bomb hit Riyadh, what would happen to the hedge fund's portfolio? If peace suddenly broke out everywhere, what would happen to the portfolio? If it turned out that the largest position exposure investment was revealed to have had fraud, what would happen to the portfolio?

Those are all risk measures, which incorporate hedges of all flavors and scenarios that must make money for investors. If they don't, the hedge fund loses out on its lavish 2 and 20 fee structure, and their world comes to an end. Think: Uber driver.

See: Sharpe Ratio.

Related or Semi-related Video

Finance: What is market risk?5 Views

00:00

Finance Allah shmoop what is market risk All right There

00:08

are a lot of risks when you invest money Two

00:10

of the most common categories are unsystematic risk And yes

00:13

of course systematic risk Also known as market risk Well

00:17

unsystematic risk refers to risks linked to a specific stock

00:21

or security So you buy shares in your dad's publicly

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traded ice cream company and the company goes bankrupt Who

00:27

knew pork rind ice cream would prove so unpopular Who

00:30

knew well that's unsystematic risk You made a bad investment

00:34

and you paid for it by losing everything you invested

00:38

un systematically Well that's individual stock risk or in systematic

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risk AII bad brain bad return What not all investments

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do well In fact many of them do poorly even

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for the best of investors So most professionals diversify their

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eggs such that not all of them are invested in

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one stock or one basket So that revolves around unsystematic

00:57

risk That is risk You can actually do something about

01:00

and improve your odds of being successful like by being

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a good smart investor But then there's market risk which

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just exists as a natural part of the risk world

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For illustrative purposes You could choose to not take any

01:13

road risk Like when you drive on the roads Your

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odds of being hit by some idiot texting his girlfriend

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and not looking at the double yellow line are not

01:21

one in a good Gillian right You also have a

01:23

risk of a tire blowout or a tree falling on

01:26

you or skidding into a mailbox on that hill with

01:28

the gravel in the oil slick from the construction people

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right Those are all quote market risks unquote of driving

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So why do it Why drive Why not just stay

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home Never leave the house get Amazon and door dash

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and ups to take care of all of your needs

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and never suffer the market risk of dying on the

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road Well for some people this probably is a good

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idea Well the same allegory lives in the stock market

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When you invest in stocks odds are extremely high that

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at some period while their value will go down maybe

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a lot You can't head yourself against things like terrorist

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attacks and natural disasters political upheaval and zombie apocalypses or

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apocalypse side They say The zombie There's no real way

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to protect yourself against market risk It's just systematic It's

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part of the system Got it So there's no way

02:15

to deal with market risk other than for one thing

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time Historically the stock market goes up over time Check

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out this glorious chart running for one hundred years in

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change for what the market is done without even calculating

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the additional return from dividends distributed along the way Well

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you can see that there has rarely been an extended

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period of time when the market didn't go up and

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or at least distribute enough in dividends Such that in

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each decade while there's been a nicely positive return from

02:42

being invested in the stock market could this suddenly change

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and go the other direction such that we have half

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a century of no growth Sure but that would be

02:51

a big departure from the way our driving has gone

02:53

in the past on the roads But you never know

02:56

There's always the N plus one idiot out there texting

02:59

and driving and you know really not giving a

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