Risk Analysis: Absolute vs.

Relative Risk

Risk Analysis:

It is the systematic study of uncertainties and risks we encounter in business, engineering, public policy,

and many other areas. Risk analysts seek to identify the risks faced by an institution or business unit,

understand how and when they arise, and estimate the impact (financial or otherwise) of adverse

outcomes. Risk managers start with risk analysis, then seek to take actions that will mitigate or hedge

these risks. Economic risk is the chance that macroeconomic conditions like exchange rates,

government regulation, or political stability will affect an investment, usually one in a foreign

country.

Why It Matters:

Economic risk is one reason international investing carries more risk than domestic investing.

Shareholders and bondholders often bear the economic risk undertaken by international companies

like Company XYZ. Investors who purchase and sell foreign government bonds are also exposed.

Economic risk may also add opportunity for investors. Foreign bonds, for example, allow investors

to participate indirectly in the foreign exchange markets and the interest rate environments of

different countries. But the foreign regulatory authorities may impose different requirements on

the types, sizes, timing, credit quality, disclosures, and underwriting of bonds issued in their

countries.
Economic risk can be mitigated by opting for international mutual funds because they provide

instant diversification, often investing in a variety of countries, instruments, currencies, or

international industries.

Absolute Risk:

Any risk in which there is no possibility of gain, only the avoidance of loss. For example, if a

company car is stolen, the company endures a loss, but if it is not stolen, the company does not

make a gain. Individuals and companies purchase insurance to mitigate the potential damage from

a loss from pure risk. It is also called absolute risk. There are four basic ways of dealing with risk:

reduce it, avoid it, accept it or transfer it.

Relative Risk:

Relative risk is a ratio of the rate of events in the population exposed to a risk factor compared

with the rate among the population not exposed to this risk factor. It tells you little about an

individuals actual risk over time.

Management that is based on absolute risk has the potential to deliver treatments to those who can

benefit the most, because absolute risk is a more meaningful way of measuring a persons actual

risk.