ALPHA UNIVERSITY LINCOLN UNIVERSITY

Postgraduate Studies and Research

Borama Awdal Somaliland

Student’s name: Abdulkadir Mohammed Fahiye

Course name: Investment and Risk Management.

➢ Define the term Investment?

In finance, Investment or investing means that an asset is bought, or that money is put into

a bank to get a future interest from it. Investment is total amount of money spent by

a shareholder in buying shares of a company. In economic management

sciences, investments means longer-term savings.

It is a term used in business management, finance and economics, related to saving or

deferring consumption. Literally, the word means the "action of putting something in to

somewhere else" (perhaps originally related to a person's garment or 'vestment').

➢ Define the term Management?

 Management is how businesses organize and direct workflow, operations, and employees

to meet company goals. The primary goal of management is to create an environment that

lets employees work efficiently and productively. A solid organizational structure serves

as a guide for workers and establishes the tone and focus of their work.

Managers are involved in implementing and evaluating these structures. As a manager,

you may be responsible for doing any of the following tasks:

• Create goals and objectives

• Create schedules

• Develop strategies to increase performance, productivity, and efficiency

• Ensure compliance with company policies and industry regulations

• Mentor employees

• Monitor budgets, productivity levels, and performance

• Resolve customer problems

• Train staff
Key functions of a manager

Managers have several functions within an organization. You'll usually see these

functions divided into four interconnected groups. Understanding them can help you

identify your strengths and areas of need to choose the proper training to improve your

skills.

Planning

The first function of a manager is to set goals. These goals may be for individual

employees, departments, or the entire organization, depending on the manager's level of

responsibility. In addition to setting goals, managers often develop action items along

with strategies and resources to complete tasks and meet goals.

Organizing

Meeting organizational goals requires putting the right people in the right places.

Managers can play an important role in choosing workers for positions and projects.

Knowing how to group people and help them build relationships significantly affects how

well the group works together. Sometimes managers need to train employees for specific

tasks to ensure they have the knowledge and skills they need to succeed.

Motivating

Managers help motivate employees to show up and stay productive. This includes sharing

a common vision, encouraging them to develop their strengths, and inspiring them to do

their best work at all times. Having effective communication skills is essential for filling

this role.

Evaluating
 Managers typically spend time measuring the success of their teams and how well they

meet goals. The more they understand what works and doesn't work, the better prepared

they are to make decisions in the future. Managers must understand and adjust strategies

to meet company goals.

➢ Define the term Risk?

In finance, risk is the probability that actual results will differ from expected results. In

the Capital Asset Pricing Model (CAPM), risk is defined as the volatility of returns. The

concept of “risk and return” is that riskier assets should have higher expected returns to

compensate investors for the higher volatility and increased risk.

Types of Risk

Broadly speaking, there are two main categories of risk: systematic and unsystematic.

Systematic risk is the market uncertainty of an investment, meaning that it represents

external factors that impact all (or many) companies in an industry or group.

Unsystematic risk represents the asset-specific uncertainties that can affect the

performance of an investment.

Below is a list of the most important types of risk for a financial analyst to consider when

evaluating investment opportunities:

• Systematic Risk – The overall impact of the market

• Unsystematic Risk – Asset-specific or company-specific uncertainty

• Political/Regulatory Risk – The impact of political decisions and changes in regulation

• Financial Risk – The capital structure of a company (degree of financial leverage or debt

burden)

• Interest Rate Risk – The impact of changing interest rates

• Country Risk – Uncertainties that are specific to a country

• Social Risk – The impact of changes in social norms, movements, and unrest

• Environmental Risk – Uncertainty about environmental liabilities or the impact of

changes in the environment

• Operational Risk – Uncertainty about a company’s operations, including its supply

chain and the delivery of its products or services

• Management Risk – The impact that the decisions of a management team have on a

company

• Legal Risk – Uncertainty related to lawsuits or the freedom to operate

• Competition – The degree of competition in an industry and the impact choices of

competitors will have on a company

Time vs. Risk

The farther away into the future a cash flow or an expected payoff is, the riskier (or more

uncertain) it is. There is a strong positive correlation between time and uncertainty.

Below, we will look at two different methods of adjusting for uncertainty that is both a

function of time.

Risk Adjustment

Since different investments have different degrees of uncertainty or volatility, financial

analysts will “adjust” for the level of uncertainty involved. Generally speaking, there are
two common ways of adjusting: the discount rate method and the direct cash flow

method.

#1 Discount Rate Method

The discount rate method of risk-adjusting an investment is the most common approach,

as it’s fairly simple to use and is widely accepted by academics. The concept is that the

expected future cash flows from an investment will need to be discounted for the time

value of money and the additional risk premium of the investment.

To learn more, check out CFI’s guide to Weighted Average Cost of Capital (WACC) and

the DCF modeling guide.

#2 Direct Cash Flow Method

The direct cash flow method is more challenging to perform but offers a more detailed

and more insightful analysis. In this method, an analyst will directly adjust future cash
 flows by applying a certainty factor to them. The certainty factor is an estimate of how

likely it is that the cash flows will actually be received. From there, the analyst simply

has to discount the cash flows at the time value of money in order to get the net present

value (NPV) of the investment. Warren Buffett is famous for using this approach to

valuing companies.

➢ Risk Management

Risk management is the process of identifying, assessing, prioritizing, and mitigating

potential risks that could negatively affect an organization, project, or objective. It

involves systematic planning and implementing strategies to minimize, monitor, and

control the impact of uncertainties or adverse events while maximizing opportunities. The

goal of risk management is to protect assets, resources, and reputation while ensuring the

achievement of organizational or project goals.

There are several approaches that investors and managers of businesses can use to

manage uncertainty. Below is a breakdown of the most common risk management

strategies:

#1 Diversification

Diversification is a method of reducing unsystematic (specific) risk by investing in a

number of different assets. The concept is that if one investment goes through a specific

incident that causes it to underperform, the other investments will balance it out.

#2 Hedging
Hedging is the process of eliminating uncertainty by entering into an agreement with a

counterparty. Examples include forwards, options, futures, swaps, and other derivatives

that provide a degree of certainty about what an investment can be bought or sold for in

the future. Hedging is commonly used by investors to reduce market risk, and by business

managers to manage costs or lock-in revenues.

#3 Insurance

There is a wide range of insurance products that can be used to protect investors and

operators from catastrophic events. Examples include key person insurance, general

liability insurance, property insurance, etc. While there is an ongoing cost to maintaining

insurance, it pays off by providing certainty against certain negative outcomes.

#4 Operating Practices

There are countless operating practices that managers can use to reduce the riskiness of

their business. Examples include reviewing, analyzing, and improving their safety

practices; using outside consultants to audit operational efficiencies; using robust

financial planning methods; and diversifying the operations of the business.

#5 Deleveraging

Companies can lower the uncertainty of expected future financial performance by

reducing the amount of debt they have. Companies with lower leverage have more

flexibility and a lower risk of bankruptcy or ceasing to operate.

 It’s important to point out that since risk is two-sided (meaning that unexpected outcome

can be both better or worse than expected), the above strategies may result in lower

expected returns (i.e., upside becomes limited).

➢ Risk management

Risk management is the identification, evaluation, and prioritization of risks, followed by

the minimization, monitoring, and control of the impact or probability of those risks

occurring. Risks can come from various sources (i.e, threats) including uncertainty in

international markets, political instability, dangers of project failures (at any phase in

design, development, production, or sustaining of life-cycles), legal liabilities, credit risk,

accidents, natural causes and disasters, deliberate attack from an adversary, or events of

uncertain or unpredictable root-cause.

Example of risk assessment: A NASA model showing areas at high risk from impact for

the International Space Station

There are two types of events wiz. Risks and Opportunities. Negative events can be

classified as risks while positive events are classified as opportunities. Risk management

standards have been developed by various institutions, including the Project Management

Institute, the National Institute of Standards and Technology, actuarial societies, and

International Organization for Standardization. Methods, definitions and goals vary

widely according to whether the risk management method is in the context of project

management, security, engineering, industrial processes, financial portfolios, actuarial

assessments, or public health and safety. Certain risk management standards have been

criticized for having no measurable improvement on risk, whereas the confidence in

estimates and decisions seems to increase.

Strategies to manage threats (uncertainties with negative consequences) typically include

avoiding the threat, reducing the negative effect or probability of the threat, transferring

all or part of the threat to another party, and even retaining some or all of the potential or

actual consequences of a particular threat. The opposite of these strategies can be used to

respond to opportunities (uncertain future states with benefits).

As a professional role, a risk manager will "oversee the organization's comprehensive

insurance and risk management program, assessing and identifying risks that could

impede the reputation, safety, security, or financial success of the organization", and then

develop plans to minimize and / or mitigate any negative (financial) outcomes. Risk

Analysts [9] support the technical side of the organization's risk management approach:

once risk data has been compiled and evaluated, analysts share their findings with their

managers, who use those insights to decide among possible solutions.

Financial Markets and Investment Instruments

Financial markets are platforms where buyers and sellers trade financial assets like

stocks, bonds, currencies, and derivatives. These markets facilitate capital raising,

liquidity, and efficient price discovery. They are broadly categorized into:

1. Capital markets (e.g., stock and bond markets).

2. Money markets (short-term instruments like treasury bills).

3. Foreign exchange markets (currency trading).

4. Derivatives markets (futures and options).

Investment instruments include assets like equities (stocks), fixed-income securities

(bonds), mutual funds, exchange-traded funds (ETFs), real estate, and alternative

investments (e.g., commodities and cryptocurrencies). These instruments help investors

achieve specific financial goals based on risk tolerance and return expectations.

Market, Credit, Operational, and Liquidity Risks

1. Market Risk:

This refers to potential losses due to changes in market factors such as stock prices,

interest rates, exchange rates, and commodity prices. For instance, a sudden decline in

stock prices can affect an investor's portfolio.

2. Credit Risk:

The risk of a borrower defaulting on their debt obligations, leading to financial loss for

the lender. A notable example is the 2008 financial crisis, where subprime mortgage

defaults affected global credit markets.

3. Operational Risk:
 This arises from inadequate or failed internal processes, systems, or human errors. For

example, cybersecurity breaches or system outages can disrupt operations.

4. Liquidity Risk:The risk of not being able to buy or sell an asset quickly without affecting its

price. This is common in times of market stress or for illiquid assets.

Risk Behavioral Finance and Decision-Making

Behavioral finance examines how psychological biases and emotions affect investors'

decisions. Common biases include:

• Overconfidence bias: Overestimating one's ability to predict market outcomes.

• Herding behavior: Following others’ investment choices, leading to market bubbles.

• Loss aversion: Focusing more on avoiding losses than achieving gains.

• Decision-making in finance is often influenced by these biases, leading to suboptimal

investment choices. Understanding these biases can help in developing strategies to

mitigate their impact on risk management.

Financial Modelling and Forecasting

Financial modeling involves creating mathematical representations of financial scenarios

to evaluate the performance of investments, businesses, or portfolios. It uses historical

data and assumptions to forecast future financial outcomes.

Forecasting predicts future financial trends based on statistical methods, economic

indicators, and market analysis. Examples include revenue projections, cash flow

forecasting, and valuation models.

Example:

During the COVID-19 pandemic, financial models were used to estimate the financial

impact of global disruptions on supply chains, helping businesses plan for revenue drops.

Case Studies

1. 2008 Global Financial Crisis:

Market risk from mortgage-backed securities and credit default swaps led to widespread

defaults and systemic failures. This emphasized the importance of credit risk assessment

and robust risk management.

2. Evergrande Crisis (2021):

China's property giant faced liquidity risks due to high leverage and slowing real estate

sales, leading to default risks and financial instability.

3. Tesla's Stock Volatility:

Market risk and behavioral finance played a significant role in Tesla's fluctuating stock

prices, driven by investor sentiment and speculative behavior.

Conclusion

Effective risk management, financial modeling, and forecasting are critical for navigating

uncertainties in financial markets. Understanding risks, behavioral influences, and market

dynamics ensures better decision-making and long-term financial stability. The

integration of case studies demonstrates the real-world application of these principles,

highlighting their importance in avoiding systemic failures and achieving sustainable

growth.

References

1. Hull, J. C. (2018). Risk Management and Financial Institutions. Wiley.

2. Kahneman, D., & Tversky, A. (1979). Prospect Theory: An Analysis of Decision

under Risk. Econometrica

3. Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining

the Value of Any Asset. Wiley.

4. Global Financial Crisis Report (2009). Financial Stability Forum.

5. Behavioral Finance: Insights into Investor Behavior (2020). CFA Institute.