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Definition of 'Risk'
The chance that an investment's actual return will be different than expected. Risk includes the possibility of losing some or all of the original investment. Different versions of risk are usually measured by calculating the standard deviation of the historical returns or average returns of a specific investment. A high standard deviation indicates a high degree of risk.
Many companies now allocate large amounts of money and time in developing risk management strategies to help manage risks associated with their business and investment dealings. A key component of the risk management process is risk assessment, which involves the determination of the risks surrounding a business or investment.
Definition of 'Risk Measures'
Statistical measures that are historical predictors of investment risk and volatility and major components in modern portfolio theory (MPT). MPT is a standard financial and academic methodology for assessing the performance of a stock or a stock fund compared to its benchmark index.
There are five principal risk measures:
Alpha: Measures risk relative to the market or benchmark index
Beta: Measures volatility or systemic risk compared to the market or the benchmark index
R-Squared: Measures the percentage of an investment's movement that are attributable to movements in its benchmark index
Standard Deviation: Measures how much return on an investment is deviating from the expected normal or average returns
Sharpe Ratio: An indicator of whether an investment's return is due to smart investing decisions or a result of excess risk.
Each risk measure is unique in how it measures risk. When comparing two or more potential investments, an investor should always compare the same risk measures to each different potential investment to get a relative performance.
