Discuss the various ways in which modern investors manage the risk in their portfolios - Essay Example

Many of the participants in risk trading take particular points of view, and suffer losses when their points of view are not realized. It may also be that the risks in some of the more complex positions currently being taken are not always well understood by the institutions arranging the deals. In addition, risk control systems in some institutions are so weak that management cannot determine when institutional survival is being jeopardized. There are also aggregate problems, because the failure of one institution can bring about failure of others.

Finally, there are presently few sources of aggregate statistics that would permit informed observers to assess exactly what the potential dangers in individual institutions’ positions might be. On the positive side, the percentage of capital at risk in derivatives trading has been estimated at some 10 percent of the total capital of the world’s banks. In addition, individual companies have sustained large losses from derivatives trading without creating serious externalities. For example, when Barings Bank failed in 1995, many of the other banks trading with Barings had become aware of the unusual risks it was taking and had reduced their positions with Barings (J.

Rosenhead, J. Mingers, 2001). Basically, the perception of risk is the result of an investors thought processes. Let us say that the investor speculates that a new factory will be able to produce V volume of goods that can be sold for P price. The question is: Where do V and P come from? Some say that V and P spring from the imagination while others maintain that V and P are a result of a deliberate cognitive process of logic and dispassionate judgment. Perhaps these, and other conjectures concerning the thought process of the human mind, are all part of a businessmans assessments of the projected values of price and volume.

These values, when properly manipulated with costs,