Quantitative risk assessments are often mathematical formulas or tools applied to financial figures. The purpose is to determine which courses of action carry the most risk compared to potential rewards. Common users of these assessments include investors and businesses. Though risk is difficult to avoid, mitigating risk can ensure a company does not lose too much capital on investments. Quantitative risk assessments often have applications throughout the business year.
Ratios are among the most common quantitative risk assessments. Ratios use mathematical formulas applied to financial information in order to determine risk. For example, leverage ratios are among the most important for measuring a company’s debt risk. A company that finances the majority of its assets with outside debt tends to be riskier than a company that finances operations through internal funds. Ratios can apply to each set of financial statements prepared by a company.
Financial markets often have quantitative risk assessments that apply to entire markets, industries, or individual stocks. The assessments here allow investors to determine the risk associated with monetary investments. For example, market risk is inherent in stock or other securities prices. Investors cannot diversify this risk away form their investments as the risk is what drives potential financial returns. Quantitative assessments such as beta, however, can indicate whether the market risk will lead to greater financial returns.
Mathematical figures are often necessary to conduct or complete quantitative risk assessments. In some cases, the figures themselves may not need to relate to actual finances or monetary amounts. A formula allows a company or individual to determine how many items to select when measuring risk. For example, a company may need to define a sample size for measuring items that might result in higher risk. Measuring risk in the sample helps the company to make inferences about larger data sets.
Risk assessments are not always going to hold true as these formulas or methods can carry some risk in and of themselves. Therefore, a company or individual must select a formula or measurement techniques that result in the least amount of error when computing the level of risk in an investment or other item. For example, using one set of financial statements to assess the risk inherent in a company is not a large sample. Multiple financial statements are necessary to create a trend for the risk analysis. This gives individuals a better idea of the risk involved in a company.
