Meaning of Risk, Risk Vs Uncertainty8th May 2021 1 By indiafreenotes
Risk implies future uncertainty about deviation from expected earnings or expected outcome. Risk measures the uncertainty that an investor is willing to take to realize a gain from an investment.
Risks are of different types and originate from different situations. We have liquidity risk, sovereign risk, insurance risk, business risk, default risk, etc. Various risks originate due to the uncertainty arising out of various factors that influence an investment or a situation.
Risk is defined in financial terms as the chance that an outcome or investment’s actual gains will differ from an expected outcome or return. Risk includes the possibility of losing some or all of an original investment.
In the ordinary sense, the risk is the outcome of an action taken or not taken, in a particular situation which may result in loss or gain. It is termed as a chance or loss or exposure to danger, arising out of internal or external factors, that can be minimized through preventive measures.
In the financial glossary, the meaning of risk is not much different. It implies the uncertainty regarding the expected returns on the investments made i.e. the probability of actual returns may not be equal to the expected returns. Such a risk may include the probability of losing the part or whole investment. Although the higher the risk, the higher is the expectation of returns, because investors are paid off for the additional risk they take on their investments. The major elements of risk are defined as below:
- Systematic Risk: Interest Risk, Inflation Risk, Market Risk, etc.
- Unsystematic Risk: Business Risk and Financial Risk.
By the term uncertainty, we mean the absence of certainty or something which is not known. It refers to a situation where there are multiple alternatives resulting in a specific outcome, but the probability of the outcome is not certain. This is because of insufficient information or knowledge about the present condition. Hence, it is hard to define or predict the future outcome or events.
|Meaning||The probability of winning or losing something worthy is known as risk.||Uncertainty implies a situation where the future events are not known.|
|Ascertainment||It can be measured||It cannot be measured.|
|Outcome||Chances of outcomes are known.||The outcome is unknown.|
The difference between risk and uncertainty can be drawn clearly on the following grounds:
- The risk is defined as the situation of winning or losing something worthy. Uncertainty is a condition where there is no knowledge about the future events.
- Risk can be measured and quantified, through theoretical models. Conversely, it is not possible to measure uncertainty in quantitative terms, as the future events are unpredictable.
- The potential outcomes are known in risk, whereas in the case of uncertainty, the outcomes are unknown.
- Risk can be controlled if proper measures are taken to control it. On the other hand, uncertainty is beyond the control of the person or enterprise, as the future is uncertain.
- Minimization of risk can be done, by taking necessary precautions. As opposed to the uncertainty that cannot be minimised.
- In risk, probabilities are assigned to a set of circumstances which is not possible in case of uncertainty.
There is an old saying, “No risk, No gain”, so if any enterprise wants to survive in the long run, it has to take calculated risks where the probability of loss is comparatively less, and the chances of gains are higher. Uncertainty is inherent in every business which cannot be avoided, and the business person has no idea about what will happen next, i.e. the outcome is unknown.