Risk analysis software: Why should you use it?

There are a number of risks associated with financial instruments and investments in the stock market. These include:

1. Counterparty

This is the chance that the issuers or backers of a financial instrument may fail to meet their commitments. It’s also known as “credit risk.” The less reliable and trustworthy the issuer, the higher the chance that the investor will not get their money back.

2. Currency

Financial instruments are valued in different currencies. Because of this, changes in the currency exchange rate may affect the price of an internationally traded asset. If investors are holding any foreign assets, they’ll have to account for this.

3. Interest rate

When interest rates change, they often impact the value of certain financial instruments. This is especially relevant for securities like bonds, which are highly sensitive to fluctuations in interest rates.

4. Leverage effect

This refers to investors potentially losing more than their initial investment itself. Financial instruments like futures contracts or option premiums are particularly vulnerable to this.

5. Liquidity

In certain cases, investors may be unable to sell or trade a particular asset quickly and easily. This depends on the liquidity of the financial instruments they rely on, which can also evolve over time.

6. Operational

This is an umbrella term for any negative developments arising in the course of regular business activities. Anything from unforeseen legal issues, lack of access to skilled workforce, drop in demand, etc fall into this category

7. Speculative

This describes the risk involved in the very nature of investing in the stock market. Investors rarely have access to perfect information, so there’s always the chance of them overlooking key details during market research. Speculative risk also arises from failing to account for other negative factors or relying too heavily on volatile investments.

8. Valuation

This refers to a discrepancy between the “book” value of an asset and its true market value when it’s sold or traded. Investing in an asset that’s overvalued may result in a less favorable transfer price---or an outright loss---when it’s eventually sold.

9. Volatility

Fluctuations in the value of a financial instrument or underlying market conditions may make assets less attractive. This volatility refers to changes in the price of an asset within a certain time frame, driven by external market conditions or other factors. It’s especially relevant for day traders who try to capitalize on these types of short-term market fluctuations.

Typically, most of the above factors will be in play at the same time. The interplay between the various sources of risk makes it challenging to account for them. That’s where risk management software comes in.

With so many variables at play, it’s impossible to keep track of these without some form of automation.

Enterprise risk management software for banks, brokers, and other financial institutions helps them make better decisions. It does this by providing insights about potential risks, generating reports, and even helping to forecast likely future scenarios.

Broadly speaking, risk analysis solutions assist with the following tasks:

1. Identify

Before you can address the risks you may be facing, you must first understand what they are. Financial risk management software can surface relevant market trends and indicators to facilitate this process. By helping with this initial risk identification, software solutions make it possible to quantify and manage potential future threats.

2. Quantify

Once you’ve identified the risks, the next step is to measure the extent of their possible negative impact. Risk assessment software can assist by pulling together relevant financial figures and presenting them in a digestible format.

Advanced financial risk management tools can even simulate future outcomes. For instance, they can generate “what if” scenarios based on available inputs and ongoing developments.

3. Mitigate

With the risks mapped out and sorted by priority, the final step is to develop a way to minimize them.

This can take the form of proactively changing the makeup of your existing portfolio to counterbalance any negative outcomes. Alternatively, it may involve developing contingency plans that you can act on if your risk profile changes due to emerging market developments.

Financial risk analysis software supports this work with reliable data, actionable reporting dashboards, and predictive forecasting models.

There’s a wealth of available digital tools that help manage risk. They can assist investors with the following:

1. Data aggregation

With any type of threat assessment, the sheer volume of available data is a challenge in its own right. That’s why risk analytics software will usually be able to import, parse, and aggregate data from multiple sources, then store that data for future use.

This significantly speeds up and simplifies the task of pulling together relevant facts and figures.

2. Reporting

Most risk management solutions can supply standard reports or allow users to create their own. Investors can then view these reports within a dashboard or download them in various formats (PDF, CSV, XLS, etc). This makes it easy to share them with other stakeholders or store them for future reference.

3. KRI Monitoring

Usually, institutions and investors will define their own set of key risk indicators (KRIs). These are similar to key performance indicators (KPIs): They aim to provide an at-a-glance picture of the current level of risk.

Risk management software can help keep an eye on these KRIs and visualize them in e.g. a dashboard. It’s even possible to set up live alerts that give an early warning of any negative KRI trends so that these can be tackled in a timely manner. By setting thresholds for acceptable KRI performance, you can delegate the work of monitoring these to your risk analysis tool.

4. Analysis

As discussed, accounting for every source of risk is a massive task. Fortunately, risk management solutions can streamline this process. Such tools can apply artificial intelligence and algorithms to turn generic risk data into actionable insights that you’re able to act upon.

In addition, software can use advanced modeling to spot, analyze, and prioritize risk factors. This demystifies future threats, helping investors formulate plans for any eventuality.

5. Audits

Risk management tools can assist with both internal and external audits. For instance, such software can perform operational audits to see how good the organization is at both identifying and responding to new developments.

Additionally, these types of solutions can perform data audits. This focuses on the quality of the market data itself by looking at its historical performance to spot inconsistencies, unreliable signals, and so on.

6. Asset valuation

Certain financial instruments may be tricky to evaluate based on readily available prices and market data. In such cases, you can find portfolio risk management software that provides so-called “fair value pricing.” This relies on using e.g. mark-to-model pricing methods to provide independent valuations of assets that aren’t frequently traded.

By using these forms of pricing models, investors can ensure that the book value of their assets closely matches their true market price. This helps to reduce the valuation risk discussed above.

7. Compliance management

Failing to account for risk isn’t just bad for your bottom line. You may also find yourself in breach of laws and regulations that govern the extent of permitted risk exposure. Risk assessment solutions help prevent this by discovering whether you’re compliant with local or international guidelines.