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Definition: Risk Management
Risk management is one area of finance. Risk is involved with any kind of investment. Risk management is to manage the risk in certain way so that the overall risk associated with the investment is reduced. There can be different kind of risks. For example- Interest risk, risk of default associated with bonds, currency risk associated with overseas investment etc.
Risk management is a vast area. To understand risk management let us consider the currency risk associated with investment. Suppose a person residing in India is holding US bond which makes the payment in US dollars after 5 years. Now the person is not sure what will be the exchange rate of US-INR after 5 years. At present if the rate is Rs 50 = $1. It might not be the same after 5 years.
So there is a currency risk involved. To protect his/her investment the person will try to hedge this currency risk by buying Future/ Forward contracts which will be settled after 5 years. In this contract he fixes the exchange rate as Rs 49 = $1. In this way he is making sure that he will get at least Rs 49 for each $ from the bond.