Month: October 2020

Employee relations may be defined as those policies and practices which are concerned with the management and regulation of relationships between the organisation, the individual staff member, and groups of staff within the working environment.

An organization can’t perform only with the help of chairs, tables, fans or other non-living entities. It needs human beings who work together and perform to achieve the goals and objectives of the organization.

The human beings working together towards a common goal at a common place (organization) are called employees. Infact the employees are the major assets of an organization.

The success and failure of any organization is directly proportional to the labour put by each and every employee.

The employees must share a good rapport with each other and strive hard to realize the goal of the organization. They should complement each other and work together as a single unit. For the employees, the organization must come first and all their personal interests should take a back seat.

Employee Relations

Every individual shares a certain relationship with his colleagues at the workplace. The relationship is either warm, so-so or bad. The relationship can be between any one in the organization – between co workers, between an employee and his superior, between two members in the management and so on. It is important that the employees share a healthy relationship with each other to deliver their best performances.

An individual spends his maximum time at the workplace and his fellow workers are the ones with whom he spends the maximum hours in a day. No way can he afford to fight with his colleagues. Conflicts and misunderstandings only add to tensions and in turn decrease the productivity of the individual. One needs to discuss so many things at work and needs the advice and suggestions of all to reach to a solution which would benefit the individual as well as the organization.

No individual can work alone. He needs the support and guidance of his fellow workers to come out with a brilliant idea and deliver his level best.

Employee relations refer to the relationship shared among the employees in an organization. The employees must be comfortable with each other for a healthy environment at work. It is the prime duty of the superiors and team leaders to discourage conflicts in the team and encourage a healthy relationship among employees.

Life is really short and it is important that one enjoys each and every moment of it.Remember in an organization you are paid for your hard work and not for cribbing or fighting with each other. Don’t assume that the person sitting next to you is your enemy or will do any harm to you. Who says you can’t make friends at work, infact one can make the best of friends in the office. There is so much more to life than fighting with each other.

Observation says that a healthy relation among the employees goes a long way in motivating the employees and increasing their confidence and morale. One starts enjoying his office and does not take his work as a burden. He feels charged and fresh the whole day and takes each day at work as a new challenge. If you have a good relation with your team members you feel going to office daily. Go out with your team members for a get together once in a while or have your lunch together. These activities help in strengthening the bond among the employees and improve the relations among them.

An employee must try his level best to adjust with each other and compromise to his best extent possible. If you do not agree to any of your fellow worker’s ideas, there are several other ways to convince him. Sit with him and probably discuss with him where he is going wrong and needs a correction. This way he would definitely look up to you for your advice and guidance in future. He would trust you and would definitely come to your help whenever you need him. One should never spoil his relations with his colleagues because you never know when you need the other person.

Avoid using foul words or derogatory sentences against anyone. Don’t depend on lose talk in office as it spoils the ambience of the place and also the relation among the employees. Blame games are a strict no no in office.

One needs to enter his office with a positive frame of mind and should not unnecessarily make issues out of small things. It is natural that every human being can not think the way you think, or behave the way you behave. If you also behave in the similar way the other person is behaving, there is hardly any difference between you and him. Counsel the other person and correct him wherever he is wrong.

It is of utmost importance that employees behave with each other in a cultured way, respect each other and learn to trust each other. An individual however hardworking he is, cannot do wonders alone. It is essential that all the employees share a cordial relation with each other, understand each other’s needs and expectations and work together to accomplish the goals and targets of the organization.

Every individual at the workplace shares a certain relationship with his fellow workers. Human beings are not machines who can start working just at the push of a mere button. They need people to talk to, discuss ideas with each other and share their happiness and sorrows. An individual cannot work on his own, he needs people around. If the organization is all empty, you will not feel like sitting there and working. An isolated environment demotivates an individual and spreads negativity around. It is essential that people are comfortable with each other and work together as a single unit towards a common goal.

It is important that employees share a healthy relation with each other at the work place.

• There are several issues on which an individual cannot take decisions alone. He needs the guidance and advice of others as well. Sometimes we might miss out on important points, but our fellow workers may come out with a brilliant idea which would help us to achieve our targets at a much faster rate. Before implementing any plan, the pros and cons must be evaluated on an open forum where every employee has the right to express his opinions freely. On your own, you will never come to know where you are going wrong, you need people who can act as critic and correct you wherever you are wrong. If you do not enjoy a good relation with others no one will ever come to help you.
• Work becomes easy if it is shared among all. A healthy relation with your fellow workers would ease the work load on you and in turn increases your productivity. One cannot do everything on his own. Responsibilities must be divided among team members to accomplish the assigned tasks within the stipulated time frame. If you have a good rapport with your colleagues, he will always be eager to assist you in your assignments making your work easier.
• The organization becomes a happy place to work if the employees work together as a family. An individual tends to lose focus and concentration if his mind is always clouded with unnecessary tensions and stress. It has been observed that if people talk and discuss things with each other, tensions automatically evaporate and one feels better. Learn to trust others, you will feel relaxed. One doesn’t feel like going to office if he is not in talking terms with the person sitting next to him. An individual spends around 8-9 hours in a day at his workplace and practically it is not possible that one works non stop without a break. You should have people with whom you can share your lunch, discuss movies or go out for a stroll once in a while. If you fight with everyone, no one will speak to you and you will be left all alone. It is important to respect others to expect the same from them.
• An individual feels motivated in the company of others whom he can trust and fall back on whenever needed. One feels secure and confident and thus delivers his best. It is okay if you share your secrets with your colleagues but you should know where to draw the line. A sense of trust is important.
• Healthy employee relations also discourage conflicts and fights among individuals. People tend to adjust more and stop finding faults in each other. Individuals don’t waste their time in meaningless conflicts and disputes, rather concentrate on their work and strive hard to perform better. They start treating each other as friends and try their level best to compromise and make everyone happy.
• A healthy employee relation reduces the problem of absenteeism at the work place. Individuals are more serious towards their work and feel like coming to office daily. They do not take frequent leaves and start enjoying their work. Employees stop complaining against each other and give their best
• It is wise to share a warm relation with your fellow workers, because you never know when you need them. You may need them any time. They would come to your help only when you are nice to them. You might need leaves for some personal reasons; you must have a trusted colleague who can handle the work on your behalf. Moreover healthy employee relations also spread positivity around.

Objectives

1. Sound employee relations are based on
   • effective mechanisms for communication and participation.
   • a safe and effective work environment.
   • commitment and motivation of all staff.
2. Accordingly, the University’s policies and practice are aimed at
   • promoting channels of communication at all levels.
   • identifying and expanding common areas of interest between all staff.
   • anticipating and defusing conflict wherever possible.
   • encouraging staff to articulate concerns and conflict and seek resolution of underlying issues.
   • providing channels for conflict resolution and developing mutual trust in their reliability.

Employee representation

1. The University Council recognises the principle of freedom of association.
2. Where staff members choose to have a trade union represent them, the University will make arrangements for recognition, collective bargaining and dispute resolution.
3. All staff members have the right to join the representative body of their choice, but this does not mean that the University will recognise all such bodies for collective bargaining or other purposes. Moreover, while acknowledging that the membership policy of the representative body is the prerogative of its members, the University is committed to maintaining non-racial conditions of employment.
4. Staff members have the right not to belong to a representative body. The University Council will not therefore agree to membership of a representative body becoming a condition of service or appointment.

Victimisation / coercion

1. No staff member shall be victimised by University management as a result of his/her membership of a representative body.
2. University management will seek to protect staff members from being coerced into membership of any association against their wishes, or from being coerced in any way as a result of their non-membership of any association.

Collective bargaining

1. The University Council will recognise a representative body for the purposes of collective bargaining on behalf of staff members in a defined common interest group (the bargaining unit) where the majority of staff members in the bargaining unit demonstrate their wish to have that body represent them.
2. Such recognition shall be formalised in a recognition (or procedural) agreement with the representative body. This agreement shall include details of the following:
   1. The bargaining unit – definition of the common interest group.
   2. Procedures – how negotiations, disputes, grievances, disciplinary matters etc. will be handled. Recognition and procedural agreements between the University and the NEHAWU, the recognition agreement was revoked in 1999 and a new recognition agreement concluded in 2000. Recognition and procedural agreements between the University and the UCT Employees’ Union were signed in 1986 and 1991 respectively. Recognition and procedural agreements between the University and the Academics’ Union were signed in 2010.

Communication and consultation

The University Council recognises the importance of open communication and joint consultation between management and staff. It therefore encourages the exchange of information, ideas and views about matters of mutual interest and concern through both formal and informal channels.

1. Informal systems

The University Council encourages informal communication and consultation at all levels. Department and section heads are encouraged to develop appropriate arrangements to promote discussion of any matters of interest and concern at the workplace.

2. Consultative committees

Where a recognition agreement has been entered into, the administration will arrange regular consultative committee meetings between Human Resources Department staff and other key members of management and the union. The role of the consultative committees is to provide a formal channel of communication between management and employee representative bodies. In particular, management will seek staff members’ views prior to taking decisions affecting their interests. In the same way, staff members bring their issues of concern to the attention of management.

The University administration and employee representative bodies are free to initiate agenda items.

Grievance resolution

The University Council considers it essential that, where a staff member (or a group of staff members) is dissatisfied for any reason arising from the work situation or employment relationship, this should be articulated and resolved as quickly as possible, at the lowest possible level.

A procedure for addressing grievances has been agreed with the NEHAWU, the UCT Employees’ Union and the Academics’ Union.

Discipline

A staff member is required to maintain certain standards of conduct. Any staff member who fails to maintain acceptable standards of conduct in accordance with his/her employment contract, specific position requirements and/or the University’s rules, renders himself/herself liable to disciplinary action. Such disciplinary action is designed to be corrective and to improve conduct (other than where dismissal is warranted) and should be taken as soon as possible after the event.

Poor performance

A staff member is required to maintain certain standards of performance. A staff member who fails to maintain laid-down standards of performance in accordance with his/her employment contract, specific position requirements and/or the University’s rules, renders himself/herself liable to corrective action.

Employee relations training

The University provides staff training to promote informed and sound employee relations practices.

1. Staff induction course

Induction courses and refresher training sessions are provided to ensure that staff are familiar with the University’s policies and procedures.

2. Management/supervisory training

Staff who manage others are provided with training in the skills necessary to give effect to the University’s policies (eg. communicating and consulting).

Parallel bargaining is bargaining in which unions negotiate provisions covering wages and other benefits that are similar to those provided in other agreements within the industry or region. It is also called pattern bargaining.

In parallel or pattern bargaining, a union determines a sequence for negotiations with firms within an industry where the agreement with the first firm becomes the take-it-or-leave-it offer by the union for all subsequent negotiations. For example, a union might target company, push hard for the best contract it could get and declare the new terms to be the “pattern.” If the other companies in that industry didn’t follow suit, labor unrest would likely follow.

Pattern bargaining is a process in labour relations, where a trade union gains a new and superior entitlement from one employer and then uses that agreement as a precedent to demand the same entitlement or a superior one from other employers.

In the United States, pattern bargaining was pioneered by unions such as the United Auto Workers and the Teamsters. The first step of the bargaining process is the identification of a target employer that is most likely to agree to a favourable employment contract. For the selected company, this provides an opportunity to influence the contract for the industry, while the downside is the risk of a labour disruption if negotiations stall or fail. Once this contract has been successfully negotiated and ratified by the unionized workers, the union declares it a “pattern agreement” and presents it to the other employers as a take-it-or-leave-it offer.

In Australia, pattern bargaining was specifically outlawed under the now-repealed WorkChoices legislation. The law was repealed by the Labor Party after their victory in the 2007 election, but Labor’s Fair Work Act, which came into force on 1 July 2010, still outlaws pattern bargaining.

For both union and management

1. Collective bargaining process should give due consideration to hear the problems on both sides. This will develop mutual understanding of a problem which is more important for arriving at the solutions.
2. Both the management and union should analyze the alternatives to arrive at the best solution.
3. There must be mutual respect on both the parties. The management should respect the unions and the unions should recognize the importance of management.
4. Both the union and management must have good faith and confidence in discussion and arriving at a solution.
5. Collective bargaining required effective leadership on both sides, on the union side and management side to moderate discussions and create confidence.
6. In collective bargaining both the union and management should observe the laws and regulations in practice in arriving at a solution.
7. In all negotiations, the labour should be given due consideration – in wage fixation, in working conditions, bonus etc.

For Management

1. Management should think of realistic principles and policies for labour regulations.
2. The recognitions of a trade union to represent the problems is more essential. If there are more than one union, the management can recognize on which is having the support of majority of workers. 
3. Management should follow a policy of goodwill, and cooperation in collective bargaining rather than an indifferent attitude towards the union.
4. Managements need not wait for trade union to represent their grievances for settlement. Management can voluntarily take measures to settle the grievances.

5. Managements should give due consideration to social and economic conditions of workers in collective bargaining.

For Unions 

1. Unions should avoid undemocratic practices.
2. Unions have to recognize their duties to the management also before emphasizing their demands.
3. Unions have to consider the benefits to all workers rather than a section of workers.
4. Strike lock-outs should be resorted to, only as a last measure. As far as possible they have to be avoided by compromise and discussion.

The Collective Bargaining is a technique to reach a mutual agreement between the employer and the employee. Here the representatives of both the parties viz. The union and the employer meet and discuss the economic issues such as wage, bonus, number of working hours and other employment terms.

The process of collective bargaining comprises of five steps that are followed by both the employee and the employer to reach an amicable solution.

• Preparation: At the very first step, both the representatives of each party prepares the negotiations to be carried out during the meeting. Each member should be well versed with the issues to be raised at the meeting and should have adequate knowledge of the labor laws.

The management should be well prepared with the proposals of change required in the employment terms and be ready with the statistical figures to justify its stand.

On the other hand, the union must gather adequate information regarding the financial position of the business along with its ability to pay and prepare a detailed report on the issues and the desires of the workers.

• Discuss: Here, both the parties decide the ground rules that will guide the negotiations and the prime negotiator is from the management team who will lead the discussion. Also, the issues for which the meeting is held, are identified at this stage.

 The issues could be related to the wages, supplementary economic benefits (pension plans, health insurance, paid holidays, etc.), Institutional issues(rights and duties, ESOP plan), Administrative issues (health and safety, technological changes, job security, working conditions).

• Propose: At this stage, the chief negotiator begins the conversation with an opening statement and then both the parties put forth their initial demands. This session can be called as a brainstorming, where each party gives their opinion that leads to arguments and counter arguments.
• Bargain: The negotiation begins at this stage, where each party tries to win over the other. The negotiation can go for days until a final agreement is reached. Sometimes, both the parties reach an amicable solution soon, but at times to settle down the dispute the third party intervenes into the negotiation in the form of arbitration or adjudication.
• Settlement: This is the final stage of the collective bargaining process, where both the parties agree on a common solution to the problem discussed so far. Hence, a mutual agreement is formed between the employee and the employer which is to be signed by each party to give the decision a universal acceptance.

Thus, to get the dispute settled the management must follow these steps systematically and give equal chance to the workers to speak out their minds.

Employee Relationship Management or ERM is the process of managing relationships in an organisation. These relationships can be between the organisation and employees as well as co-workers working at the same level.

For employees to be productive, they need to have a working environment that allows them to be creative. When employees have an easy-going relationship with others at work, it will show in their performance and productivity. There will be more communication, collaboration and cooperation.

An effectively managed ERM will pave the way for a fulfilling employee experience and a feeling of satisfaction from the work your employees do.

It is rightly said that the success and failure of an organization is directly proportional to the relationship shared among the employees. The employees must share a cordial relation otherwise they would always end up fighting with each other. Nothing is possible without trust. You need to trust people to expect the best out of them. Trust only comes when you are comfortable with the other person. An individual can’t always take decisions alone. Employees together can discuss things among themselves, come out with innovative ideas and accomplish the tasks at a much faster rate.

A human resource professional plays a key role in binding the employees together. He/she must undertake certain activities which help in strengthening the bond among the employees and bring them closer.

The individual taking care of the HR activities plays a key role in involving all the employees into something productive which would give them an opportunity to know each other well. Individuals are so engrossed in their daily routine work that they hardly get time to interact with each other. Many of them don’t even know the full names of the person sitting next to their workstations. The human resource department must ensure that several group activities are being organized at the workplace to bring all employees on a common platform.

Research says that if the employees are satisfied with their job responsibilities, they tend to remain happy and avoid conflicts with each other. Individuals develop a feeling of trust and loyalty towards their organization and don’t waste their time and energy in unproductive tasks.

Organize various activities like potlucks and small get togethers at the workplace. Ask each one to bring some dish according to his taste and convenience. Let the employees enjoy together. Employees tend to discuss lot many things apart from routine work in these kinds of informal get togethers.

One day probably the last day of the month should be earmarked with the sole objective of celebrating birthdays falling in the particular month. For example all those born in the month of May should celebrate their birthdays together on the last day of the month i.e. 31st May which will help a great deal for them to remain charged for next one year. The HR should send a formal mail inviting all. Let everyone enjoy and have fun. Divide individuals into groups and ask each group to do something. One group can probably be responsible for the decoration of the venue; the other group can take care of the cake as well as other eatables and so on. The HR person should ideally support each group to ensure that no one faces any difficulty in getting things organized.

It is the responsibility of the human resources team to organize various events like sports day, annual day, green day etc. The employees must be encouraged to participate in these kinds of extracurricular activities. Employees are able to relax this way and take a break from their routine work. Problems crop up when the work tends to become monotonous. Employees should enjoy coming to office, rather than treating work as a burden.

The HR in coordination with the team leaders must display the names of the top performers every month on the company’s noticeboard. Send a congratulations mail as well. The human resource professional along with the supervisor can even hand over a small trophy as a token of appreciation to the top performers. Do this activity in the presence of all. The one who has performed well starts trusting his management more and strives hard to win many more trophies in the future. Everyone is aware about each other’s performance and gets inspired as well.

While making the organization’s policies, the human resource department must fix a common time for lunch for all the employees. Assign half an hour for the same and make sure that no one during the lunch time is seen working at their workstations. Everyone should come together at the office canteen and take lunch together. When people sit together, half of their problems disappear on their own. Employees share their sorrows, displeasures and various other problems with their colleagues and this way come closer to each other. People develop better bonding this way.

When a new employee joins an organization, make sure he receives a warm welcome by all. The induction program should be conducted at the auditorium or the conference room so that everyone can be invited. Ask the new joinee to introduce himself well. Let others know that a new member has stepped into their family to help them in their assignments.

The HR along with the line managers must communicate the key responsibility areas clearly to the employees to extract the best out of them and avoid dissatisfactions later.

Value at Risk (VaR) is a financial metric that estimates the risk of an investment. More specifically, VaR is a statistical technique used to measure the amount of potential loss that could happen in an investment portfolio over a specified period of time. Value at Risk gives the probability of losing more than a given amount in a given portfolio.

Key Elements of Value at Risk

• Specified amount of loss in value or percentage
• Time period over which the risk is assessed
• Confidence interval

Methods Used for Calculating VaR

1. Historical Method

The historical method is the simplest method for calculating Value at Risk. Market data for the last 250 days is taken to calculate the percentage change for each risk factor on each day. Each percentage change is then calculated with current market values to present 250 scenarios for future value. For each of the scenarios, the portfolio is valued using full, non-linear pricing models. The third worst day selected is assumed to be 99% VaR.

Where:

vi is number of variables on day i

m is the number of days from which historical data is taken

2. Parametric Method

The parametric method is also known as the variance-covariance method. This method assumes a normal distribution in returns. Two factors are to be estimated an expected return and a standard deviation. This method is best suited to risk measurement problems where the distributions are known and reliably estimated. The method is unreliable when the sample size is very small.

Let loss be ‘l’ for a portfolio ‘p’ with ‘n’ number of instruments.

3. Monte Carlo Method

Under the Monte Carlo method, Value at Risk is calculated by randomly creating a number of scenarios for future rates using non-linear pricing models to estimate the change in value for each scenario, and then calculating the VaR according to the worst losses. This method is suitable for a great range of risk measurement problems, especially when dealing with complicated factors. It assumes that there is a known probability distribution for risk factors.

Marginal Value at Risk (MVaR)

The marginal value at risk (MVaR) method is the amount of additional risk that is added by a new investment in the portfolio. MVaR helps fund managers to understand the change in a portfolio due to the subtraction or addition of a particular investment. An investment may individually have a high Value at Risk, but if it is negatively correlated with the portfolio, it may contribute a relatively much lower amount of risk to the portfolio than its standalone risk.

Incremental Value at Risk

Incremental VaR is the amount of uncertainty added to, or subtracted from, a portfolio due to buying or selling of an investment. Incremental VaR is calculated by taking into consideration the portfolio’s standard deviation and rate of return, and the individual investment’s rate of return and portfolio share. (The portfolio share refers to what percentage of the portfolio the individual investment represents.)

Conditional Value at Risk (CVaR)

This is also known as the expected shortfall, average value at risk, tail VaR, mean excess loss, or mean shortfall. CVaR is an extension of VaR. CVaR helps to calculate the average of the losses that occur beyond the Value at Risk point in a distribution. The smaller the CVaR, the better.

Advantages of Value at Risk (VaR)

1. Easy to understand

Value at Risk is a single number that indicates the extent of risk in a given portfolio. Value at Risk is measured in either price units or as a percentage. This makes the interpretation and understanding of VaR relatively simple.

2. Applicability

Value at Risk is applicable to all types of assets – bonds, shares, derivatives, currencies, etc. Thus, VaR can be easily used by different banks and financial institutions to assess the profitability and risk of different investments, and allocate risk based on VaR.

3. Universal

The Value at Risk figure is widely used, so it is an accepted standard in buying, selling, or recommending assets.

Limitations of Value at Risk

1. Large portfolios

Calculation of Value at Risk for a portfolio not only requires one to calculate the risk and return of each asset but also the correlations between them. Thus, the greater the number or diversity of assets in a portfolio, the more difficult it is to calculate VaR.

2. Difference in methods

Different approaches to calculating VaR can lead to different results for the same portfolio.

3. Assumptions

Calculation of VaR requires one to make some assumptions and use them as inputs. If the assumptions are not valid, then neither is the VaR figure.

The transactions in secondary market are processed through three distinct phases, viz. trading, clearing and settlement. While the stock exchange provides the platform for trading to its trading members, the clearing corporation determines the funds and securities obligations of the trading members and ensures that trading members meet their obligations.

The clearing banks and depositories provide the necessary interface between the custodians/clearing members (who clear for the trading members or their own transactions) for settlement of funds and securities obligations of trading members.

Stock Exchange

The clearing process involves determination of what counter-parties owe, and what counter-parties are due to receive on the settlement date. It is essentially the process of determination of obligations, after which the obligations are discharged by settlement. To illustrate, the clearing and settlement process for transactions in securities on NSE is presented.

Several entities, like clearing corporation, clearing members, custodians, clearing banks, depositories, are involved in the process of clearing. The roles of each of these entities are explained below:

i) Clearing Corporation:

The clearing corporation is responsible for post-trade activities of a stock exchange. Clearing and settlement of trades and risk management are the central functions for a clearing corporation.

ii) Clearing Members:

Clearing members can be of two types: (i) those who are trading as well as clearing members; these members trade as well as take the responsibility to settle their trades, and (ii) those who act only as clearing members; these members do not trade but take on the responsibility to settle the trades of other trading members. They are responsible for settling their obligations as determined by the clearing corporation. They have to make available funds and/or securities in the clearing account or pool account, as the case may be, to meet their obligations on the settlement day.

iii) Custodians:

Custodians are clearing members but not trading members. They settle trades on behalf of other trading members. A trading member may assign a particular trade to a custodian for settlement. The custodian is required to confirm whether he is going to settle that trade or not. If it confirms to settle that trade, then clearing corporation assigns that particular obligation to that custodian and the custodian is required to settle it on the settlement day.

iv) Clearing Banks:

Clearing banks are a key link between the clearing members and clearing corporation for funds settlement. Every clearing member is required to open a dedicated clearing account with one of the clearing banks. Based on the clearing member’s obligation as determined through clearing, the clearing member makes funds available in the clearing account for the pay-in and receives funds in case of a pay-out.

v) Depositories:

Depository helps in the settlement of the dematerialised securities. It holds dematerialised securities of the investors in the beneficiary accounts. Each clearing member is required to maintain a clearing pool account with all the depositories. Separate accounts are required to be opened for the settlement of trades on different stock exchanges.

The clearing members are required to provide the securities as per their obligations in the clearing pool account on settlement day. At a pre-determined time, the depository sends the information about the availability of securities in the clearing pool accounts of the clearing member to the clearing corporation.

In stock market there is strong relationship between risk and return. Greater the risk, greater the return generally! In financial terminology risk management is the process of identifying and assessing the risk and then developing strategies to manage and minimize the same while maximizing the returns.

Every investment demands a certain amount of risk and for an investor to assume this risk he has to be compensated duly. This compensation is in the form of something called as the risk premium or simply the premium. Risk is therefore central to stock markets or investing because without risk there can be no gains. Successful investors use stock market risk management strategies to minimize the risk and maximize the gain.

In financial markets there are generally two types of risk; first the Market risk and second the Inflation risk. Market risk results from a possibility in increase or decrease of financial markets. The other risk i.e. the Inflation or the purchasing power risk results from rise and fall of prices of goods and services over time.

The inflation risk is an important consideration in long term investments where as the market risk is more relevant in the short term. It is the market risk that can be managed and controlled to a certain extent, inflation risk cannot be controlled.

There are certain strategies that can be employed to mitigate the risk in a stock market. The strategies are as follows:

• Follow the trend of the market: This is one of the proven methods to minimize risks in a stock market. The problem is that, it is difficult to spot trends in the market and trends change very fast. A market trend may last a single day, a month or a year and again short-term trends operate within long term trends.
• Portfolio Diversification: Another useful risk management strategy in the stock market is to diversify your risk by investing in a portfolio. In a portfolio you diversify your investment to several companies, sectors and asset classes. There is a probability that while the market value of a certain investment decreases that of the other may increase. Mutual Funds are yet another means to diversify the impact.
• Stop Loss: Stop loss or trailing tool is yet another device to check that you don’t lose money should the stock go far a fall. In this strategy the investor has the option of making an exit if a certain stock falls below a certain specified limit. Self-discipline is yet another option employed by some investors to sell when the stock falls below a certain level or when there is a steep fall.

Portfolio diversification

Businesses are susceptible to several uncertainties that adversely affect their stock prices. To protect your portfolio from big losses, invest in multiple stocks. This ensures that even if some of your investments do not perform as expected, the others minimise their effect on the overall portfolio. While diversifying, make sure to invest in stocks that don’t have much in common. Investing in similar stocks exposes you to the same risks and defeats the purpose of diversification. For example, automobile and auto ancillary may seem like different sectors, but they are affected by similar factors. Investing in both these sectors may not help much with risk mitigation.

Remember, diversification does not mean investing equally in all sectors. It means investing in more than one asset or sector.

You can invest more in companies you are more optimistic about. But don’t commit so much that you cannot bear the losses if things go bad.

Using stop-losses

A stop-loss order authorizes your broker to automatically sell a stock when it falls to a specific level. This protects you from excessive losses during sharp market corrections. It also checks your tendency to sit on a loss-making stock for too long in the hope that it rebounds. For example, if you bought a stock for Rs.100 with a stop-loss of Rs.90, your broker will automatically sell the stock when it falls to Rs.90. This can protect you from further losses if the stock falls below Rs.90.

Adding non-cyclical to the portfolio

These are stocks of companies that sell essential goods and, as such, are relatively insulated from economic cycles. Examples include pharmaceutical and Fast-Moving Consumer Goods (FMCG) stocks. Why you wonder? This is because people cannot stop spending on healthcare and groceries, irrespective of the state of the economy. At best, they may reduce their spending on some essential goods and services. As such, non-cyclical stocks have relatively stable revenues, which translate into stable stock prices. You may find many experts call them ‘Defensives’.

Hedging

Hedging refers to the use of derivative instruments, such as Futures and Options contracts, for risk management in equity. A futures contract helps you to fix the price for a future buy/sell transaction in the future. This way, you can cut down the risk of price fluctuations. For example, even if the price of your stock falls, you can sell it at the higher price that you fixed. Similarly, you can buy at lower rates even if the price rises thanks to derivatives contracts. There are different types of such derivatives contracts that you can use. We’ll read about these in depth in the Derivatives section.

Investing in dividend-paying stocks

Companies that have a history of consistent dividend payments are usually strong, established companies. Adding them to your portfolio can shield you from equity risk.

Companies are generally reluctant to cut their dividends because the market perceives a dividend cut as a sign of poor financial health. As such, dividend-paying stocks also ensure that you receive a constant stream of returns, even if their prices fall. They reduce risk by bringing more predictability and stability to your portfolio.

Opting for blue-chips

Not all stocks have the same risk. Stocks of smaller or medium-sized companies can be riskier and more volatile in the stock market. This is because such companies are more prone to various business risks. Established companies, meanwhile, can be more stable. This extends to their stock prices too. So, you can reduce risk by opting for such stocks.

Pairs trading

This is a good way to mitigate equity risk when you are anticipating a big price move, but are not sure of its direction. An example is when a big regulatory decision is expected to be made, but you don’t know what the decision will be. In such cases, you simultaneously buy the stock of one company and short sell (i.e. sell first and cover by buying later) the stocks of another company from the same sector. Ensure that both stocks are not related and are likely to benefit in different ways.