RISKS IN FINANCIAL MARKETS

A financial market is a much wider term describing any marketplace where buyers and
sellers participate in the trade of assets such as equities, bonds, currencies and derivatives. A
financial market is a market in which people trade financial securities, commodities and other fungible
items of low transaction costs and prices that reflect supply and demand.

Financial markets are typically defined by having transparent pricing, basic regulations on
trading, costs and fees, and market forces determining the prices of securities that trade.
Investors have access to a large number of financial markets and exchanges representing a vast array of
financial products.

Need for the study

Risk is uncertainty and uncertainty lies opportunity. Considering the post 2008 market scenario if you
want

Objective of the study

 To get exposures to the various financial risks in the markets.

 To limit any negative impact on financial position.
 Detection of risks and vulnerabilities which can affect the stake of the organization.

Some examples of risks associated with financial markets

Risks associated with financial markets include uncertainty, volatility, default risk, counterparty risk and
interest rate risk. Different asset classes have different types of risk.

Volatility
Volatility is a major risk for all markets. Volatility is the uncertainty in the change of an asset’s value. A
higher level of volatility indicates larger moves and a wider change in the asset's value. Volatility is a
non-directional value. A higher volatility asset has as good a likelihood of making a larger move up as it
does down, which means they have a larger impact on the value of a portfolio. Some investors like
volatility, while others try to avoid it as much as possible.

Counterparty Risk

Counterparty Risk is part of the derivatives swap market. Counterparty risk is the risk one party in a
credit swap may default on an agreement. Credit swaps are the exchange of cash flows between two
parties and are based on changes in the underlying interest rates. Counterparty defaults on swap
agreements were one of the main causes of the 2008 financial crisis.

Default Risk

Default is found in the bond and fixed income markets. It is the risk that a borrower may default on its
loan obligations and not pay the lender outstanding amounts. Generally, a higher possibility of default
results in a larger amount of interest paid on a bond. Thus, there is a risk/reward trade-off investors
must consider.

Interest Rate Risk

Interest rate risk is another risk in the bond market wherein the price of bonds decrease with a rise in
interest rates.

The possibility that shareholders will lose money when they invest in a company that has debt, if the
company's cash flow proves inadequate to meet its financial obligations.

When a company uses debt financing, its creditors are repaid before its shareholders if the company
becomes insolvent.

Financial risk also refers to the possibility of a corporation or government defaulting on its bonds, which
would cause those bondholders to lose money.

Types of financial Risks

Asset-Backed Risk - An asset-backed security (ABS) is a financial security backed by a loan, lease
or receivables against assets other than real estate and securities. For investors, asset-backed securities
are an alternative to investing in corporate debt.

Types of risk in ABS

▪ Pre-payment risk: This risk arises when the borrowers pay more than their required monthly
installments, thereby reducing the interest on the loan.
▪ Credit risk: The risk associated with a borrower going into default. Investor losses include lost principal
and interest, decreased cash flow, and increased collection costs.

Liquidity Risk

Liquidity risk is the risk that a company or are unable to meet short term financial demands. This usually
occurs due to the inability to convert a security or hard asset to cash without a loss of capital or income
in the process.

How it works: For example, when a business or individual with immediate cash needs, holds a valuable
asset that it cannot trade or sell at market value due to a lack of buyers, or due to an inefficient market
where it is difficult to bring buyers and sellers together.

Why it Matters: Purchasers and owners of long term assets must take into account the salability of
assets when considering their own short term cash needs. Assets that are difficult to sell in an ill-liquid
market carry a liquidity risk since they cannot be easily converted to cash at a time of need. Liquidity
risk may lower the value of certain assets or businesses due to the increased potential of capital loss.

For example, consider a $1,000,000 home with no buyers. However, due to the home owner’s need of
cash to meet near term financial demands, the owner may be unable to wait and have no other choice
but to sell the house in an illiquid market at a significant loss. Hence, the liquidity risk of holding this
asset.

Types of liquidity risk

▪ Market liquidity – An asset cannot be sold due to lack of liquidity in the market – essentially a sub-set
of market

▪ Funding liquidity – Risk that liabilities: Cannot be met when they fall due Can only be met at an
uneconomic price Can be name-specific or systemic.

Market Risk

Market risk is the possibility for an investor to experience losses due to factors that affect the overall
performance of the financial markets in which he is involved. Market risk, also called "systematic risk,"
cannot be eliminated through diversification, though it can be hedged against. Sources of market risk
include recessions, political turmoil, and changes in interest rates, natural disasters and terrorist attacks.
The two major categories of investment risk are market risk and specific risk. Specific risk, also called
"unsystematic risk," is tied directly to the performance of a particular security and can be protected
against through investment diversification. One example of unsystematic risk is a company declaring
bankruptcy, making its stock worthless to investors.
Market Risk Due to Volatility

Market risk exists because of price changes. The standard deviation of changes in prices of stocks,
currencies or commodities is referred to as price volatility. Volatility is rated in annualized terms. It may
be expressed as an absolute number, such as $10, or a percentage of the initial value, such as 10%.
Value at Risk-To measure market risk, investors and analysts use the value at risk method. The value at
risk method is a well-known and established risk management method, but it comes with some
assumptions that limit its correctness.

Operational Risk

Operational risk summarizes the risks a company undertakes when it attempts to operate within a given
field or industry. Operational risk is the risk not inherent in financial, systematic or market-wide risk. It is
the risk remaining after determining financing and systematic risk, and includes risks resulting from
breakdowns in internal procedures, people and systems. Operational risk can be summarized as human
risk; it is the risk of business operations failing due to human error. Industries with lower human
interaction are likely to have lower operational risk.

Model Risk

Risk of loss resulting from using models to make decisions initially and frequently in the context of
valuing financial securities. Rebonato defines model risk as “the risk of occurrence of a significant
difference between the mark-to-model value of a complex and illiquid instrument, and the price at
which the same instrument is revealed to have traded in the market”

Types of model risk: ▪ Wrong model ▪ Model implementation ▪ Model usage

How to deal with investment risks

The fact is that you cannot get rich without taking risks. Risks and rewards go hand in hand; and,
typically, higher the risk you take, higher the returns you can expect. In fact, the first major Zurich Axiom
on risk says: "Worry is not a sickness but a sign of health. If you are not worried, you are not risking
enough". Then the minor axiom says: "Always play for meaningful stakes".

The secret, in other words, is to take calculated risks, not reckless risks.

In financial terms, among other things, it implies the possibility of receiving lower than expected return,
or not receiving any return at all, or even not getting your principal amount back.

Every investment opportunity carries some risks or the other. In some investments, a certain type of risk
may be predominant, and others not so significant. A full understanding of the various important risks is
essential for taking calculated risks and making sensible investment decisions.

Seven major risks are present in varying degrees in different types of investments
Business risk

The market value of your investment in equity shares depends upon the performance of the company
you invest in. If a company's business suffers and the company does not perform well, the market value
of your share can go down sharply.

This invariably happens in the case of shares of companies which hit the IPO market with issues at high
premiums when the economy is in a good condition and the stock markets are bullish. Then if these
companies could not deliver upon their promises, their share prices fall drastically.

When you invest money in commercial, industrial and business enterprises, there is always the
possibility of failure of that business; and you may then get nothing, or very little.

A recent example of a banking company where investors were fallen to business risk was of Global Trust
Bank. Global Trust Bank, promoted by Ramesh Gelli, slipped into serious problems towards the end of
2003 due to NPA-related issues.

However, the Reserve Bank of India's decision to merge it with Oriental Bank of Commerce was timely.
While this protected the interests of stakeholders such as depositors, employees, creditors and
borrowers was protected, interests of investors, especially small investors were ignored and they lost
their money.

The greatest risk of buying shares in many budding enterprises is the promoter himself, who by
overstretching or swindling may ruin the business.

Liquidity risk

Money has only a limited value if it is not readily available to you as and when you need it. In financial
jargon, the ready availability of money is called liquidity. An investment should not only be safe and
profitable, but also reasonably liquid.

An asset or investment is said to be liquid if it can be converted into cash quickly, and with little loss in
value. Liquidity risk refers to the possibility of the investor not being able to realize its value when
required. This may happen either because the security cannot be sold in the market or prematurely
terminated, or because the resultant loss in value may be unrealistically high.

Current and savings accounts in a bank, National Savings Certificates, actively traded equity shares and
debentures, etc. are fairly liquid investments. In the case of a bank fixed deposit, you can raise loans up
to 75% to 90% of the value of the deposit; and to that extent, it is a liquid investment.

Some banks offer attractive loan schemes against security of approved investments, like selected
company shares, debentures, National Savings Certificates, Units, etc. Such options add to the liquidity
of investments.
The relative liquidity of different investments is highlighted in Table.

Table

Liquidity of Various Investments

Liquidity Some Examples

Very high Cash, gold, silver, savings and current accounts

in banks, G-Secs

High Fixed deposits with banks, shares of listed

companies that are actively traded, units,
mutual fund shares

Medium Fixed deposits with companies enjoying high

credit rating, debentures of good companies
that are actively traded

Low and very Deposits and debentures of loss-making and

low cash-strapped companies, inactively traded
shares, unlisted shares and debentures, real
estate

Don't, however, be under the impression that all listed shares and debentures are equally liquid assets.
Out of the 8,000-plus listed stocks, active trading is limited to only around 1,000 stocks. A-group shares
are more liquid than B-group shares. The secondary market for debentures is not very liquid in India.
Several mutual funds are stuck with PSU stocks and PSU bonds due to lack of liquidity.

Purchasing power risk or inflation risk

Inflation means being broke with a lot of money in your pocket. When prices shoot up, the purchasing
power of your money goes down. Some economists consider inflation to be a disguised tax.

Given the present rates of inflation, it may sound surprising but among developing countries, India is
often given good marks for effective management of inflation. The average rate of inflation in India has
been less than 8% p.a. during the last two decades.

However, the recent trend of rising inflation across the globe is posing serious challenge to the
governments and central banks. In India's case, inflation, in terms of the wholesale prices, which
remained benign during the last few years, began firming up from June 2006 onwards and topped
double digits in the third week of June 2008. The skyrocketing prices of crude oil in international
markets as well as food items are now the two major concerns facing the global economy, including
India.
Ironically, relatively "safe" fixed income investments, such as bank deposits and small savings
instruments, etc., are more prone to ravages of inflation risk because rising prices erode the purchasing
power of your capital. "Riskier" investments such as equity shares are more likely to preserve the value
of your capital over the medium term

Political risk

The government has extraordinary powers to affect the economy; it may introduce legislation affecting
some industries or companies in which you have invested, or it may introduce legislation granting debt-
relief to certain sections of society, fixing ceilings of property, etc.

One government may go and another come with a totally different set of political and economic
ideologies. In the process, the fortunes of many industries and companies undergo a drastic change.
Change in government policies is one reason for political risk.

Whenever there is a threat of war, financial markets become panicky. Nervous selling begins. Security
prices plummet. In case a war actually breaks out, it often leads to sheer pandemonium in the financial
markets. Similarly, markets become hesitant whenever elections are round the corner. The market
prefers to wait and watch, rather than gamble on poll predictions.

International political developments also have an impact on the domestic scene, what with markets
becoming globalized. This was amply demonstrated by the aftermath of 9/11 events in the USA and in
the countdown to the Iraq war early in 2003. Through increased world trade, India is likely to become
much more prone to political events in its trading partner-countries.

Market risk

Market risk is the risk of movement in security prices due to factors that affect the market as a whole.
Natural disasters can be one such factor. The most important of these factors is the phase (bearish or
bullish) the markets are going through. Stock markets and bond markets are affected by rising and
falling prices due to alternating bullish and bearish periods: Thus:

 Bearish stock markets usually precede economic recessions.

 Bearish bond markets result generally from high market interest rates, which, in turn, are
pushed by high rates of inflation.

 Bullish stock markets are witnessed during economic recovery and boom periods.

 Bullish bond markets result from low interest rates and low rates of inflation.
How to manage risks

Not all the seven types of risks may be present at one time, in any single investment. Secondly, many-a-
times the various kinds of risks are interlinked. Thus, investment in a company that faces high business
risk automatically has a higher liquidity risk than a similar investment in other companies with a lesser
degree of business risk.

It is important to carefully assess the existence of each kind of risk, and its intensity in whichever
investment opportunity you may consider. However, let not the very presence of risk paralyse you into
inaction. Please remember that there is always some risk or the other in every investment option; no
risk, no gain!

What is important is to clearly grasp the nature and degree of risk present in a particular case – and
whether it is a risk you can afford to, and are willing to, take.

Success skill in managing your investments lies in achieving the right balance between risks and returns.
Where risk is high, returns can also be expected to be high, as may be seen from Figure 1.

Figure 1: The Risk-Return Trade-Off

Once you understand the risks involved in different investments, you can choose your comfort zone and
stay there. That's the way to wealth.
The Top 8 Risks Of The Financial Markets In 2016

Strong Dollar

From mid-2001 through mid-2008, the U.S. dollar trended lower relative to most major currencies. A
weak dollar is a tailwind for U.S. exports as it makes American-made products less expensive to foreign
consumers. Around the middle of 2014, a few months before the Fed ceased its monetary expansion,
the dollar began to strengthen. As the dollar gained strength, large U.S. companies that derive a
significant portion of revenue overseas saw profits decline. From the third quarter 2014 through the first
quarter 2015, U.S. corporate earnings fell 20%. What causes the dollar to gain strength? Let’s look at this
now.

#2 The Federal Reserve, Interest Rates, and the Dollar

If the U.S. floods the world with dollars, it could produce an oversupply thereby causing its value to fall.
Interest rates are another factor that affects a currency’s value. For example, when the Fed raises
interest rates, the dollar becomes more appealing, which increases demand and causes its value to rise.
In late 2015, the Fed raised its short-term interest rate for the first time in nearly a decade. Normally the
Fed raises rates when economic activity is improving. Although the U.S. economy is faring better than
the rest of the world, it is far from overheating. Why did the Fed raise rates if the economy is still a bit
sluggish? So it will be better prepared if the economy slows. In other words, the Fed has “reloaded its
gun,” even if only slightly. If the Fed continues to raise rates, it should have a suppressing effect on the
economy and eventually cause the dollar to strengthen further.

#3 Oil Prices and the Energy Sector

After peaking in July 2014, crude oil prices began to collapse. Even though cheaper oil reduces gasoline
prices, which helps U.S. consumers and businesses, it also hurts the energy sector and related industries.
The oil decline has led to an increase in bankruptcies, loan defaults, and unemployed workers. Think of it
as an energy tsunami rippling through the U.S. economy. Where is the benefit of cheaper gasoline? We
will address this in Risk #8 (fiscal policy).

#4 Middle East

The Middle East has been a hotbed of conflict for thousands of years and many OPEC members are
located in the region. As crude prices fell, the U.S. fracking industry found that it could no longer extract
oil at a profit and many companies closed. Even though there are fewer oil companies today, Russia,
Brazil, Venezuela, and others continued to drill and export because their economies are suffering. In
short, they need the revenue. This is a chief reason that the supply will remain strong, keeping oil prices
at the low end of the spectrum throughout 2016. Of course if a natural disaster or conflict occurs,
disrupting the extraction or transportation of oil, prices would likely spike. In the absence of such an
event, I expect the status quo to continue.
#5 China

The Chinese government spent many years building infrastructure. This was a key factor in China’s
incredible, but unsustainable, economic growth. Since the construction noise has ceased, the structures
(a.k.a. “ghost cities”) remain unoccupied. This caused a dramatic slowdown in China’s GDP and triggered
fear in the financial markets in the region and around the globe. Ironically, from January 1, 2014 to June
12, 2015, the Shanghai Composite rose 144.2%, even though the economy was slowing. Many believe
the Chinese government contributed to the meteoric rise. In any event, as is the case with all bubbles,
eventually the selling accelerated, the bubble burst, and stock prices plummeted. Because China is the
second largest economy in the world, the fallout has been felt around the globe.

#6 Inflation/Deflation

Most understand that inflation exists when prices are rising. Conversely, deflation is a prolonged period
of falling prices and can be destructive to an economy. The Fed has established an inflation target of
2.0%. Through the end of November 2015, inflation was 0.5% for the trailing 12 months, well below the
Fed’s target rate. A strengthening dollar also tends to keep inflation low since we import a great deal of
what we consume. Inflation is a bit like Goldilocks and the Three Bears. If it is too high, it hurts
consumption. If it is too low, deflation may result. However, deflation is much worse than inflation
unless inflation is extremely elevated.

#7 U.S. Stock Market Risk: The VIX

The VIX is not really a risk per se, but a measure of stock market risk. The VIX (Volatility Index) measures
the expected volatility (i.e. risk) of the stock market over the next 30 days. When the VIX rises, stocks
have a very strong tendency to fall and vice versa. To explain, the VIX reached an all-time high of 80.86
during the 2008 financial crisis. The long-term average of the VIX is 19.40. As of this writing, the VIX is
23.21. Although the current reading is slightly elevated, unless we experience a serious negative event,
the current level of the VIX is not much of a concern. However, this can change rapidly. Therefore, it is
worth watching.

#8 U.S. Fiscal Policy

Many people wonder why the Fed was so aggressive when it reduced interest rates to zero and
massively expanded the money supply. There is also confusion over why such aggressive Fed policy
failed to stimulate the economy as it has in the past. The reason for the ineffectiveness of the Fed’s
easy-money policy is fiscal policy. Fiscal policy lies in the realm of the government and involves
government spending, regulations, and tax policy. Last July, I asked two Fed District Presidents why the
Fed has been so aggressive with monetary policy. Their answer was quite revealing. First, the Fed
wanted to let individuals and businesses know that it would do whatever was necessary to help the
economy grow. Secondly, the Fed acted in the extreme because fiscal policy has been a drag on the
economy. More concisely, massive new regulations and higher taxes are suppressing economic growth.
Conclusion

There are always risks in the world. With a stronger dollar, a tightening Fed, an oversupply of oil, a weak
global economy, and anti-growth U.S. fiscal policy, what should investors do? It depends on your time
horizon and willingness to accept risk. In general, you should consider a low allocation to U.S. stocks,
high-quality short-term U.S. bonds, and cash. Add to that a few specific alternative investments such as
certain commodities, select currencies, etc. For those willing to assume the risk, shorting an index could
produce a positive result. Remember, if you decide to invest in foreign markets, be sure to hedge the
dollar. The U.S. financial markets will likely experience some degree of pain this year but the majority of
the fallout should be overseas. In short, the financial markets in 2016 may look similar to 2015 with a
little twist. The global economy should improve but only slightly (0.3%). There is not much to get excited
about at the moment.

Avoid Financial Risk: Advice from Successful Investors

Many thousands of successful people have been interviewed over the years in an attempt to discover
their so-called “secrets of successful investments” in order to avoid financial risk. Here are some of their
recommendations:

Investment Strategies Of Successful People

First, if you are not a bit worried about your speculations or your financial risk, then you are not
investing enough. You should have enough money invested so that it is a real concern to you. You are
far more likely to make the right decision when you are emotionally involved because of the size of your
investment. You are also more likely to watch that investment more carefully in order to avoid financial
risk.

Second, always take your profit too soon. “Conquer greed,” just as Bernard Baruch says. There is a
saying in the stock market that “bulls make money and bears make money, but pigs never
do.” Eliminate as much risk as possible and keep an eye on your personal finances.

Third, distrust anyone who claims to predict the future, since all financial outcomes are loaded with
uncertainty. This means that every investment is a gamble of some kind and will contain some financial
risk. No one can tell you with exact accuracy what is going to happen in the future with regard to any
stock or investment. Everyone is guessing the very best way they know how.

Fourth, when the ship starts to sink, don’t pray, jump. In other words, accept the small losses cheerfully
as a fact of investing life. At the very best, fully 50% of investments will go wrong. They will actually
decline in value. They will fail to realize your hopes and expectations for them. But you can still succeed
in investing if you minimize your losses on the downside so that you can maximize your profits on the up
side.
Fifth, luck is the most powerful single factor in investment success. Because there are no predictable
patterns in investing in the stock market, for you to be successful, you need a lot of luck. A good
question for you to ask is, “How much of my personal finances am I willing to entrust to luck?”

Sixth, never fall in love with an investment. Successful people never become emotionally involved with
anything that you purchase with the intention of making a profit. This rule also includes real estate,
especially your home. Many people fall in love with their investments and are reluctant to admit they
have made a mistake. As a result, they ride them all the way down into the cellar, and often end up
setting themselves back by several years.

Seventh, never confuse a hunch with a hope. Many people hope that a particular stock or investment is
a good one. They then say that they have a very good hunch that it’s going to go up. Consciously
separate your hunches from your hopes and don’t confuse the two when it comes to your personal
finances.

Eighth, optimism means expecting the best, but confidence comes from knowing how you will handle
the worst. To put it another way, confidence springs from the constructive use of pessimism.

The method that successful people recommend is for you always to ask, “What is the worst possible
thing that can happen in this situation?” Always be willing to face the worst possible outcome. John
Paul Getty, at one time the richest man in the world, said that his secret for success in investing was to
objectively asses the worst possible outcome of any business deal, and then to make very sure that it
didn’t happen.

Ninth, disregard the majority opinion. Think through every decision for yourself. Don’t allow your
investment decisions to be influenced by anyone else. Take the time to think them through personally,
and then take full responsibility for each financial risk and choice that you make.

Tenth, if it doesn’t pay the first time, forget it. If, based on the information you have, you decide to
invest in a stock and it doesn’t work out, sell the stock and go on to something else. Successful people
keep their completely out of the equation. A very wealthy man once told me that, “Investment
opportunities are like buses; there will always be another one along.”

Financial Risk And Your Personal Finances

The above advice is practiced by many of the most successful people who have ever invested in
stocks. Remember, the stock market is highly speculative and a financial risk. It is dominated and
controlled by people who are making their livings by buying and selling stock for others. And these
people make mistakes every single day.

There are no full proof ways for making money in the stock market. If you are going to invest in stocks,
be careful. Do your homework and watch your investments all of the time.
About Brian Tracy — Brian is recognized as the top sales training and personal success authority in the
world today. He has authored more than 60 books and has produced more than 500 audio and video
learning programs on sales, management, business success and personal development, including
worldwide bestseller The Psychology of Achievement. Brian's goal is to help you achieve your personal
and business goals faster and easier than you ever imagined

3 strategies to help reduce investment risk

Key Points

 Use caution when making investing decisions based on concerns about short-term gains or
losses.

 Review your asset allocation and diversification strategies to ensure your risk and reward levels
align with your long-term investment goals.

 Dollar-cost averaging may help smooth out the effect of market volatility over time and because
it’s done systematically, can help remove the emotion from your financial decisions

History shows that when people invest and stay invested, they're more likely to earn positive returns in
the long run. When markets start to fluctuate, it may be tempting to make financial decisions in reaction
to changes to your portfolio. But people who base their financial decisions on emotion often end up
buying when the market is high and selling when prices are low. These investors ultimately have a
harder time reaching their long-term financial goals.

How can you avoid making these common investing mistakes? These are some investment strategies,
which can help you reduce the risks associated with investing and potentially earn more consistent
returns over time.

Strategy 1: Asset allocation

Appropriate asset allocation refers to the way you weight the investments in your portfolio to try to
meet a specific objective — and it may be the single most important factor in the success of your
portfolio.

For instance, if your goal is to pursue growth, and you're willing to take on market risk to reach that
goal, you may decide to place as much as 80% of your assets in stocks and as little as 20% in bonds.
Before you decide how you'll divide the asset classes in your portfolio, make sure you know your
investment timeframe and the possible risks and rewards of each asset class.
Risks and rewards of major asset classes

Stocks

 Can carry a high level of market risk over the short term due to fluctuating markets.

 Historically earn higher long-term returns than other asset classes.

 Generally outpace inflation better than most other investments over the long term.

Bonds

 Generally have less severe short-term price fluctuations than stocks and therefore offer lower
market risk.

 Can preserve principal and tend to provide lower long-term returns and have higher inflation
risks over time.

 Bond prices are likely to fall when interest rates rise (if you sell a bond before it matures, you
may get a higher or lower price than you paid, depending on the direction of interest rates)

Money market instruments

 Among the most stable of all asset classes in terms of returns, money market instruments
carry low market risk (managers of these securities try to keep the per-share price at $1 and
distribute returns as dividends)

 Generally don't have the potential to outpace inflation by a large margin

 Not insured or guaranteed by the Federal Deposit Insurance Corporation or any other
government agency (there’s no guarantee that any fund will maintain a stable $1 share price)

Different asset classes offer varying levels of potential return and market risk.

For example, unlike stocks and corporate bonds, government T-bills offer guaranteed principal and
interest — although money market funds that invest in them do not. As with any security, past
performance doesn't necessarily indicate future results. And asset allocation does not guarantee a
profit.

Strategy 2: Portfolio diversification

Asset allocation and portfolio diversification go hand in hand.

Portfolio diversification is the process of selecting a variety of investments within each asset class to
help reduce investment risk. Diversification across asset classes may also help lessen the impact of
major market swings on your portfolio.
 How portfolio diversification works

If you were to invest in the stock of just one company, you'd be taking on greater risk by relying
solely on the performance of that company to grow your investment. This is known as "single-
security risk" — the risk that your investment will fluctuate widely in value with the price of one
holding.

But if you instead buy stocks in 15 or 20 companies in several different industries, you can reduce
the potential for a substantial loss. If the return on one investment is falling, the return on another
may be rising, which may help offset the poor performer.

Keep in mind, this doesn’t eliminate risk, and there is no guarantee against investment loss.

Strategy 3: Dollar-cost averaging

Dollar-cost averaging is a disciplined investment strategy that can help smooth out the effects of
market fluctuations in your portfolio.

With this approach, you apply a specific dollar amount toward the purchase of stocks, bonds and/or
mutual funds on a regular basis. As a result, you purchase more shares when prices are low and
fewer shares when prices are high. Over time, the average cost of your shares will usually be lower
than the average price of those shares. And because this strategy is systematic, it can help you avoid
making emotional investment decisions.

Above were the strategies to reduce or to avoid investment risks in financial market.

How dollar-cost averaging might work in rising and declining markets

In the illustration below, the cost of the investment ranges between $10 and $25 from January through
April. A fixed monthly investment of $100 buys as many as 10 shares when the price is lowest but only
four shares when the price is highest. In this example, dollar-cost averaging results in a lower average
share price during the period, while the market average price — for someone who bought an equal
number of shares each month is higher.
Dollar-cost averaging at $100 per month

Rising market

Month When the price is You buy

January $10 10.00 shares

February $15 6.67 shares

March $20 5.00 shares

April $25 4.00 shares

Declining market

Month When the price is You buy

January $25 4.00 shares

Declining market

Month When the price is You buy

January $25 4.00 shares

February $20 5.00 shares

March $10 10.00 shares

April $5 20.00 shares

Five actionable steps to boost your finance department’s risk management strategy

Risk is inevitable in all business decisions and operations, but can only be managed properly when the
right strategies are put in place. Finance departments are particularly exposed to risk for any number of
reasons, including but not limited to regulatory changes, security breaches and fraud.

Many companies are using large ERP systems, such as SAP, for governance, risk and compliance (GRC) to
better manage risk and comply with highly complex financial, compliance and regulatory audits.
However, with rapidly evolving audit requirements, merely implementing GRC solutions is not enough.
Instead, organisations need to put a comprehensive risk management strategy in place that will protect
themselves from future risk.

There are five critical elements that a successful risk management strategy should incorporate: (i)
defined roles and responsibilities; (ii) established policies and procedures; (iii) transparency in reporting;
(iv) optimized technology; and (v) documented retention policies.
Defined roles and responsibilities

While organizations generally understand and control financial risks, there are risks in other areas of the
business that are sometimes overlooked. To mitigate these broader risks, organisations must ensure
that the correct roles and responsibilities are in place. It is also important to ensure that all transactions
adhere to organisational standards for approval hierarchies and separation of duties through well-
defined roles and responsibilities. At a minimum, organisations should consult members of the finance,
legal and IT departments to determine specific regulations and requirements. In the event of an audit,
having established specific risk management roles and responsibilities will ensure that the required
controls are not only put in place, but monitored over time.

Established policies and procedures

Articulate and accurate policies and procedures aid in reducing risk within finance departments but they
must be aligned with government requirements, regulations and standards. Well-designed, automated
procedures can help to reduce risk during key financial processes. Automating procedures using data
validation and workflow rules can improve the speed of processing and reduce human error. For
example, if an invoice has a three-way match – purchase order, invoice and goods receipt – then the
invoice can be completed electronically within seconds because it meets all of the process
requirements. Policies to manage exceptions must be established and understood to ensure compliance
with organisational standards, such as levels of authority and separation of duties. Other procedures to
manage the capture of orders, remittances, invoices or journal entries through portals or other
electronic methods will increase accuracy and reduce risk due to rejections, handling errors and delays.
Lastly, structured workflows ensure that processes are executed consistently, according to corporate
policy, across distributed locations.

Digitization improves transparency

Transparency reduces risk; therefore, digitised processes are less risky because users can immediately
detect issues and resolve them. Digital processes are more transparent than manual or paper-based
processes as users can view the real-time status updates on orders, invoices, access to online
documents and transaction history. Issues can be resolved faster with digital processes and users can
create real-time reports to detect fraud or potential issues or establish metrics to measure performance
against departmental and corporate goals.

Besides eliminating risk, reducing paper remains a goal for companies that continue to receive a
significant portion of orders, remittances or invoices sent to the mailroom. Newer solutions, such as
portals and other electronic transmission methods, are faster and more accurate, and provide additional
two-way communication capabilities that significantly improve processes. Reducing risk while
simultaneously improving processes is a central goal to which every organisation should strive.
Optimised technology

When putting together a comprehensive risk management strategy, it is important to consider available
software options that can enhance what is available in enterprise systems such as SAP. Organisations
should consider tools that capture information required for audit purposes, such as process
diagramming solutions, which automatically document process steps and system integration points and
optical character recognition (OCR), which automatically enters large volumes of audit documentation
into the SAP system. Specialised solutions such as SAP GRC are also available to meet the audit needs of
large enterprises. Audit regulations are constantly changing, so it is important to invest in flexible tools
to meet current and future audit reporting requirements.

Data archiving is also an important consideration to reduce the cost and the risks associated with long-
term data storage. Moving archived or infrequently accessed data to a secondary storage facility ensures
that it is frozen and not vulnerable to hackers. Moving data to the cloud can reduce the cost of storing
data.

Online document retention policies

Most companies have a good understanding of how to apply retention policies to paper-based
documents, but find it difficult to ensure the same policies are applied to online documents. All
electronic and scanned documents (such as invoices, orders and goods receipts) that are generated by
online transactions and that reside in online systems must comply with the retention policies as paper-
based documents. While the process of setting up the retention policies in online systems can be
challenging for the business and IT teams, once the policies are established, following those policies is
relatively easy as digitised processes generate a complete audit trail that includes user IDs and time
stamps. It is important to ensure that information is organised so that it can be searched and accessed
at a later date and that information, when it reaches the end of its useful life, is disposed of properly.

Risk management policies, once put into place, should be reviewed regularly. They should be updated
when a business goes through a transformation, such as a merger or acquisition that adds new data or
new responsibilities, or a divestiture that has legal rules governing how data is handled. Policies should
also be reviewed and updated whenever new systems are added to the IT landscape (such as cloud
applications) or when new laws and regulations are put into place (Brexit, for example, will impact
companies doing business in EU/UP or General Data Protection Regulation). A regular review of policies
will ensure that data is protected against any new threats that may emerge, such as increased threats
from hackers going after personal or business data.

Building a risk management strategy which incorporates these five essential elements will enable
organisations to mitigate risks and meet the challenges presented by financial, compliance and
regulatory audits.
Financial Reporting, Internal Control and Risk Management

The foundation of the Groups management and internal control is its values that are defined together
with the personnel:

 Develop and improve – for the benefit of the customer

 Trust and be trustworthy

 Operate profitably

 Entrepreneurship means responsibility

The Groups´ values constitute ground rules aimed at guiding the operation of all employees. They are an
important prerequisite for the materialisation of Group strategy. The values are reflected in all day-to-
day operations, guide the personnel in achieving set targets and help to achieve the goal of the internal
control. Together determined values support the participation of the entire organisation and clarify and
facilitate both our internal and external communication.

The company's Board of Directors is responsible for the arrangement and the functionality of the
internal control. Internal control, risk management and financial reporting are overseen by the Audit
Committee nominated by the Board of Directors. Financial reporting in the Group is carried out by using
the Group´s guidelines concerning the reporting. These guidelines are maintained by the Group´s
Financial Administration. Financial Administration also oversees that these guidelines are applied and
that the internal communication conserning the guidelines is arranged properly.

Financial Reporting

Board of Directors has approved principles how to prepare consolidated financial statements. Preparing
process and controlling operations for consolidated financial statements are specified, as well as are the
job descriptions and responsibilities for preparing consolidated financial statements. Adjustments in
consolidated financial statements are made before the balances and profit and loss statements of Group
companies are booked to Group reporting system to be sure that all company accounts correspond to
principles of consolidated financial statements (IFRS). Validity of consolidation is synchronized. Turnover
and profit of group and business units are analyzed and compared to views of management and to
information from operational systems in the Control function.

Other processes that are significant for financial statements are fixed assets process and sales process.
Sales revenues of Group are booked based on information from operational systems. This process is
supervised by Group Financial Department. Significant information from sales systems are synchronized
monthly with the information in bookkeeping. In Group there are limits for accepting the purchase of
fixed assets and the accounting function of Group is also supervising purchases that are activated as
assets. Group has an accepted depreciation policy which specifies economic lifetime for goods and
components. Group accounting supervises that the depreciation periods that business units have
defined are done according to group policy. Economic lifetimes are supervised by group accounting and
inventory of fixed assets is done regularly. Depreciation periods are specified by law and by economic
lifetime according to prudence principle.

Effective internal control system requires adequate, well-timed and reliable information so that the
management can follow the achievement of goals and functionality of controls. This covers both
economic and other information, data from information systems as well as other internally and
externally gathered information. Management in different levels of Group is continuously supervising
and estimating information from financial and operational systems as well as information from internal
and external sources, and evaluates the significance of the information for the Group. Directions for
accounting and other relevant directions are available in intranet for all and accounting function
organizes on demand education related to these directions. Communication between operational units
and accounting function is regular. Profit of Group is supervised internally by monthly reporting and it is
completed by rolling forecasts. Group financial results are informed to the personnel immediately after
the official stock exchange release is published.

Instructions for insiders are available in intranet for all. President and CEO is responsible for Investor
Communications.

The auditors control the validity of Group accounting and financial statements and that the
management of the Group is organized properly. Control findings and recommendations related to them
made by auditors are reported to the Board of Directors and to the Internal Audit Committee.

Internal Control

In the Group internal control means all actions and processes, principles, instructions and organizational
structures that aim to increase the probability that all targets can be reached. Purpose of internal
control is to ensure the profitability of operations, observance of legislation and contracts, proper
administration of assets and validity of financial reporting. The Group applies its internal control in
accordance with international COSO-model.

Nurminen Logistics Group consists of parent company Nurminen Logistics Plc, subsidiaries and
associated companies. Functionally significant companies in addition to the parent company and the
Finnish subsidiary are Russian and Baltic business units which are managed in own companies.

The Board of Directors is responsible for organizing and functionality of internal control. Internal control
is managed by Group Management Team and it is executed by the whole organization. Internal control
is not a separate function but elementary part of all functions and it is working in all levels of
organization. Operational management has the main responsibility of control. Each manager is
responsible for organizing the control of the functions, which he/she is responsible for, and to follow
that the controls are continuously functional. Support functions such as financial administration, IT
department and risk management are supporting Group Management Team and have responsibility to
organize the internal control in support functions. Chief Financial Officer is responsible for processes in
financial administration and in reporting and shall organize the internal control for these functions.
Internal audit of the company is organized by President and CEO and the Audit Committee. Together
they annually decide the focus, resourcing and actions of internal audit. Goal of internal audit is to
evaluate and develop the risk management, control, management and administration processes.
Internal audit is carried out as broadened external audit.

The company does not have a separate internal audit function. Instead, the internal audit is part of the
group’s financial administration. If necessary the Group buys expert services. Contract risks are also
managed locally with the assistance of the lawyers representing Business Units. Local auditors audit the
procedures of internal control in accordance with the audit plan. Representatives of the financial
administration perform certain controls when they visit subsidiaries. The financial management reports
on the findings to the President and CEO and the Audit Committee, which in turn report to the Board of
Directors. The main focus areas of risk management have been credit and liquidity risk as well as risks
associated with railway logistics business operations.

Risk management

The Group engages in continuous risk evaluation of its operative business, and aims to protect itself
from known risk factors. The goal of the Group´s risk management is to secure the performance of the
group, and to ensure the undisturbed continuation of business. The Board's Audit Committee evaluates
the sufficiency and the appropriateness of the risk control and the processes related to it. The Audit
Committee reports to the Board of Directors.

Business risks are divided in strategic risks, financial risks, operational risks, data security risks and
indemnity risks.

The Group has established a general risk management policy, the principles of which are:

Strategic Risks

The Group systematically analyzes risks that are significant in relation to achieving the Group´s strategic
targets. Risk analysis of strategic risks and the measures caused by it are reviewed in the Board of
Directors at least once a year.

Financial Risks

The goal of the Group´s risk management is to minimise the harmful effects by the changes in financial
markets on the Group’s profit and equity. The policy for managing financial risks is based on the main
principles of finance approved by the Board of Directors. Finance operations are responsible for daily
risk management within the limits set by the Board.

Currency risks

Currency risks are caused by foreign currency imports and exports, by the financing of foreign
subsidiaries and by equity in foreign currency.
The Group manages the currency risk inherent in cash flows by keeping foreign currency income and
expense cash flows in the same currency, and by matching them simultaneously to the extent possible.
If matching is not possible, a portion of the open position may be hedged.

Foreign currency transaction risk position can be hedged if the counter value of currency exceeds EUR
500,000. Positions greater than EUR 2 million are hedged 50–110 %. Foreign currency risk of the net
translation exposure can be hedged 25–75 %. Instruments used in hedging include forward contracts
and plain vanilla options. Exotic options are forbidden. The hedge ratio is considered based on the
current economic trends and the predicted currency prospects as well as the functionality of each
currency’s hedge market. In extraordinary hedging market circumstances the company may deviate
from the guidelines above.

Currency amounts in cheque accounts should be kept as small as possible without disturbing payment
transactions. The amount of currency assets may not exceed one percent of the total of the balance
sheet.

Interest Rate Risks

Interest rate risks to the Group derive mainly through interest bearing debt. The purpose of interest rate
risk management is to diminish the effect of market interest rate movements on finance cash flows.
Usable protection instruments include forward rate agreements and interest rate futures, interest rate
swaps and interest collar agreements.

Liquidity Risk

The purpose of liquidity risk management is to ensure sufficient financing in all situations. Assets
required for two weeks’ payment transactions will be reserved as a buffer for liquidity of payment
transactions.

The Group aims to guarantee the availability and the flexibility of financing in all circumstances by
various financing agreements including sufficient credit limits and by co-operating with a number of
financing institutions.

Credit Risks

The goal of managing credit risk is to minimise losses which are caused by the other party neglecting
their obligations. The Group will manage the counterparty risk based on the customer credit rating and
engages in active debt-collection, when necessary.

Operational Risks

The operational risks consist of sales, business, personnel, IT, safety and agreement risks, risks related to
the internal processes and systems as well as of legal risks.
The Group strives to minimise the operational risks of its activities by seeking as balanced a business
revenue and expenditure structure as possible and by continually developing its own operations and
systems.

In terms of revenue structure, the Group pursues a balanced customer portfolio such that the
proportion of the Group´s business activities deriving from individual customers and industries does not
become too large.

In terms of expenditure structure, the Group strives for a flexible expenditure structure such that
outlays conform to seasonal variations in business activities.

The Group strives to minimise the agreement risks by harmonising the agreements as well as the
processes of drafting and approving the agreements.

The Group continuously develops its core processes and information systems in order to be able to
serve its customers competitively now and in the future.

It is the goal of the Group to continuously develop the possibilities for the Group and the personnel to
improve their own operating environment and to predict changes by developing procedures, systems,
tools and personnel through many different means. Regular personnel satisfaction surveys, supervisor
evaluations along with evaluations of key personnel, allow the prediction and minimization of possible
human risks.

Information Security Risks

Information security is a constant part of the securing and developing of all operations of the
Group. Information security and information security policy are the responsibility of President and CEO
and Group Management Team. They decide on the common information security policy of the Group. IT
department is responsible for the development, supervision of the implementation and the
maintenance of information security knowledge. In the end every administrator and user of the
information systems and information networks is responsible for the implementation of information
security. IT department is responsible for the protection of the information systems and for the
information that they include.

The foundation of the implementation of the information security is the information security policy
established by the Group. The policy is available for all employees and IT system users. The targets,
responsibilities and methods of implementation of the Group´s and its subsidiaries' information security
are defined in the information security policy.

The goal of the information security work is to secure the continuity of the Group´s operations and the
uninterrupted functioning of the manual and automatic information systems that are important to the
operations, to prevent the unauthorised use of the information and information systems, to prevent
unintended or intended destruction or distortion of information and to minimise the possible damages.
In addition to the protection of the information processing of normal times the Group also prepares for
the threat situations that could interrupt the Group´s operations and for the recovery from these
situations. The Group´s information, information systems and information system services are kept
properly protected through administrative, technical and other measurements both during normal and
unusual conditions. Every person handling company information is responsible for his/her part to take
care of information security.

The achievement of information security goals is an ongoing process, which includes administrative,
physical and technical resolutions. The information security risks are being investigated on regularly
basis with a goal to identify the threats that endanger the operations, to recognise the vulnerable spots
of the information systems and to estimate the losses in case some kind of threat materialises and to
estimate the costs of reconstructing the information security in order to reduce the risks.

Indemnity Risks

Significant indemnity risks to the Group are those related to the Group´s personnel, its assets,
interruption of its operations and its liability risks.

The Group continuously pays attention to the security of its operations and to maintenance of proper
working conditions. The company´s quality and environmental systems are deemed to fulfil the
requirements established for the ISO 9001:2008 and ISO 14001:2004 standards. In addition
its occupational health and safety system is certified (OHSAS 18001:2008) as well.

All terminal workers have earned an occupational safety card.

The Group utilizes deviation reporting.

In addition to statutory insurance coverage, the Group also has comprehensive property, business
interruption and liability insurance coverage to minimize indemnity risks. In order to ensure that
insurance policies offer comprehensive coverage and are priced competitively, the Group analyses its
insurance coverage yearly using external experts as necessary.