The concept of risk is at the heart of investment management. Financial analysts and portfolio managers continually identify, measure, and manage risk. In a simple world where only stocks and bonds exist, the only risks are the fluctuations associated with market values and the potential for a creditor to default. Measuring risk often takes the form of standard deviations, betas, and probabilities of default. In the above simple setting, managing risk is limited to engaging in stock and bond transactions that reduce or increase risk. For example, a portfolio manager may hold a combination of a risky stock portfolio and a risk-free bond, with the relative allocations determined by the investor’s tolerance for risk. If for some reason the manager desires a lower level of risk, the only transactions available to adjust the risk downward are to reduce the allocation to the risky stock portfolio and increase the allocation to the risk-free bond.
But we do not live in a simple world of only stocks and bonds, and in fact investors can adjust the level of risk in a variety of ways. For example, one way to reduce risk is to use insurance, which can be described as the act of paying someone to assume a risk for you. The financial markets have created their own way of offering insurance against financial loss in the form of contracts called derivatives. A derivative is afinancial instrument that offers a return based on the return of some other underlying asset. In this sense, its return is derived from another irlstrument-hence, the name.
As the definition states, a derivative’s performance is based on the performance of an underlying asset. This underlying asset is often referred to simply as the underlying.’ It trades in a market in which buyers and sellers meet and decide on a price; the seller then delivers the asset to the buyer and receives payment. The price for immediate purchase of the underlying asset is called the cash price or spot price. A derivative also has a defined and limited life: A derivative contract initiates on a certain date and terminates on a later date. Often the derivative’s payoff is determined andlor made on the expiration date, although that is not always the case. In accordance with the usual rules of law, a derivative contract is an agreement between two parties in which each does something for the other. In some cases, as in the simple insurance analogy, a derivative contract involves one party paying the other some money and receiving coverage against potential losses. In other cases, the parties simply agree that each will do something for the other at a later date. In other words, no money need change hands up front. We have alluded to several general characteristics of derivative contracts.

This struggle between investor creditor and company debtor is part of a mismatch of their risk-return appetites. Yet, there are various types of investor in the risk universe. Some are risk-bearing, some are risk-offering players.
Professional investor/shareholder
This category includes the class of professional investor – those who work in banks, fund managers and financial institutions. There are many sophisticated investors who are busy creating their own pension or playing with more than $100 000 to $1 million. They invest to accumulate wealth, sometimes losing on the way. But, this is a burgeoning section of the population.
These individuals operate in addition to the full-time professional bank/fund managers who are investing far larger sums. The different types of investor classes take various time horizons, trading strategies and asset classes.
A conservative or risk-averse investor would like to preserve the value of the original in- vestment, hence to limit the downside risk, and to make a “reasonable” return.
A risk-seeking investor or speculator, on the other hand, can be eager to engage in “double or quits” wagers on the stock market – such as Internet day-traders. In fact, it is often worse than a zero-sum game; after spreads, commissions, fees and taxes, at least 70 % of these short-term traders lose money. It is an uneven playing field just like a casino’s rules: the house always wins.
Yet, there are those in the majority of investors who take a longer term view and believe in the “prospects” of a company. These are the “rational” investors, both big and small, who occasionally get “suckered” into buying a bad stock. The stock-market crashes of 1929, 1987 or September 11th 2001, and the continuing bear run in 2003 offer testimony to the fickleness of share prices. Disaster is good for risk management business but bad for the traditional “buy-and-hold” investor philosophy.
Investment companies/Fund managers
The market is potentially teaming with sharks ,which is why we hire seasoned managers who protect us and nurture our wealth. The directors of investment companies are meant to be professionals who are hired for their ability to create and preserve shareholder value. But, when they fail, the business world either rails against investor injustice, or quietly suffers in silence, which offers no solution. Fortunately, there has been some good research done to search for effective corporate governance solutions.
Investmentbanks
These are the professionals who often rest at the centre of the market action. There are corporate bankers, brokers, company analysts who have been deemed skilled and ethical to handle the vast and valuable amounts of data in the market. Banks are paid to analyse target companies’ prospects, and also to finance and sell these companies to the investor. The chef is cooking, tasting and recommending the same dishes to customers. These roles have conflicts of interest
that have led to successful lawsuits against some Wall Street banks. Some investment banks have split their stock broker and analytical arms from their investment banking arms into different companies. It will not be a complete solution to the conflict of interest that led to the division along ‘ChineseWalls’.

The stock-market collapse has emphasised the topsy-turvy world of investor euphoria and dismay. The shareholder public has suffered a crisis in confidence in those charged with the management of their investment, chiefly the corporate directors or CEOs.
There has been a significant impact from corporate accounting scandals as two-thirds (62 %) of UK private investors are now less trusting of all company reports and accounts.
What is true seems to be a disconnection between real risk and a perceived “good investment” and the investor votes with his wallet.
Certainly, the investor has turned to regulatory safeguards in desperation, but the protection may turn out to be rather cosmetic at times. More realistically, there is a limit to help and compensation that can be provided post facto. Or that the public naively placed too much faith in the FSA, SEC or FDIC in getting back all (or most) of their losses. This market is full of unrealistic expectation.