The degree of risk is the potential for failure that is taken on when choosing to engage in various types of business deals and investments. Sometimes referred to as volatility, the degree or potential of risk involved in a particular transaction will vary, based on a number of factors. In general, investors and others who engage in trades or purchases will look closely at the risk factors present with a given transaction, project the potential of those factors to derail the deal, and then weigh that level of risk against the potential rewards and benefits. If the degree of risk is found to be acceptable in comparison to the rewards, there is a good chance the investor will move forward with the transaction.
One of the easiest ways to understand the degree of risk is to consider the purchase of an even lot of securities issued by a particular company. As part of the process of considering that purchase, the investor will take the time to research the past performance of those shares, with an eye toward understanding how those shares have performed under certain economic conditions. The investor will also consider the current financial status of the company issuing the shares, and the potential for those circumstances to either remain favorable in the future or to improve within a reasonable period of time. As a last consideration, the investor will assess the future movement of the market in which the shares are traded and attempt to project if those shares have a good chance of increasing in value and generating returns. If the overall degree of risk is considered acceptable, then the purchase is made and the shares are added to the investor’s portfolio.
Lenders also consider the extension of loans based on what they perceive as the degree of risk associated with a specific applicant. Typically, factors such as the income level of the applicant, credit score, current ratio between income and outstanding debt, and past management of credit cards and other loans will all provide some insight into what type of risk the applicant poses to the lender. Should the lender feel the risk associated with approving an application is within reason, then the loan will be approved.
It is important to note that the degree of risk associated with any investment or transaction is somewhat subjective, often based on the standards of the investor. This means an investment considered too risky by one investor may be considered acceptable by another. For this reason, attempting to match the mindset of the investor with the type of investments that are within the bounds of the investor’s willingness to take on risk is one of the primary tasks that brokers perform on behalf of their clients.