Risk – a quantifiable probability of damage, loss or injury occurring.
Risks are present for banks when they lend capital as there is the possibility that it may not be paid back. The market imposes a risk, since general trade can influence interest rates and exchange rates, which then impacts several countries across the globe. There is also risk in investment as the ROI may not be as high as expected.
Uncertainty – the probability of each outcome of a particular situation is unpredictable
Making an uncertain decision is more than risky as it may be impossible to say how likely a particular outcome may be. Uncertainty makes businesses less likely to invest.
Causes of uncertainty:
- Changes in Gov. policy
- Changes in consumer preferences
- Sudden changes in costs
- Innovation from competitors (affects profits)
Shocks – unforeseen changes which impact the economy
Shocks affect many aspects of business and the economy. Examples of shocks include changes in oil prices, the Global financial crisis and changes in commodity prices. The rise in oil prices may come as a result of OPEC restricting supply. As demand for oil is inelastic, consumers will have to pay higher prices for this necessity. These rising prices lead to inflation as oil prices affect transport costs which will rise affecting prices for many other goods.
EXCHANGE RATE RISK AND FORWARD MARKETS
Fluctuations in exchange rates cause uncertainty for businesses as they cannot be certain of their export revenues. Depreciation can benefit exporters, making them more price-competitive whilst importers benefit from appreciation of currencies which reduces their overall costs. Changes in exchange rates affect profits, incomes and employment opportunities.
One way to lower uncertainty is through forward markets which involves buying or selling an asset with an agreed price in the present, but a delivery and payment in the future. This is used primarily in the foreign exchange market due to the uncertainty of fluctuating exchange rates. These contracts made in forward markets are called futures. Using these markets means that a business has agreed a price and it will not change.
ROLE OF INSURANCE IN BUSINESS
Insurance is used to reduce risks of decisions. Firms (and people) will take out insurance policies for which they have to pay a premium. This premium is the price paid to cover a risk. Businesses may include the price of an insurance policy in their costs which helps them prevent against large losses.