what does marginal risk mean ?

Introduction

Marginal risk is a measure of the additional risk that a new investment position adds to a firm or portfolio. It is calculated by taking the difference between the portfolio’s risk before and after the new position is added. Marginal risk can be used to help risk managers make decisions about which investments to add to or remove from a portfolio.

For example, let’s say a firm has a portfolio of stocks with a total risk of 10%. If the firm then adds a new stock with a risk of 5%, the marginal risk of the new stock is 5%. This means that the new stock adds 5% of additional risk to the portfolio.

Marginal risk can also be used to compare different investments. For example, let’s say a firm is considering two different stocks, Stock A and Stock B. Stock A has a risk of 5% and Stock B has a risk of 10%. The marginal risk of Stock A is 0%, while the marginal risk of Stock B is 5%. This means that Stock A adds no additional risk to the portfolio, while Stock B adds 5% of additional risk.

How is Marginal Risk Calculated?

Marginal risk can be calculated using a variety of methods. One common method is to use the following formula:

Marginal Risk = (New Portfolio Risk - Old Portfolio Risk) / New Position Size

In this formula, the “New Portfolio Risk” is the risk of the portfolio after the new position is added. The “Old Portfolio Risk” is the risk of the portfolio before the new position is added. The “New Position Size” is the size of the new position, expressed as a percentage of the total portfolio size.

How is Marginal Risk Used?

Marginal risk can be used in a variety of ways. It can be used to help risk managers make decisions about which investments to add to or remove from a portfolio. It can also be used to compare different investments. In addition, marginal risk can be used to calculate the risk of a portfolio over time.

For example, a risk manager might use marginal risk to decide whether to add a new stock to a portfolio. The risk manager would first calculate the marginal risk of the new stock. If the marginal risk is low, the risk manager might decide to add the stock to the portfolio. However, if the marginal risk is high, the risk manager might decide to reject the stock.

Marginal risk can also be used to compare different investments. For example, a company might be considering two different investment options, Option A and Option B. Option A has a marginal risk of 5%, while Option B has a marginal risk of 10%. This means that Option A adds 5% of additional risk to the portfolio, while Option B adds 10% of additional risk. The company might decide to choose Option A because it has a lower marginal risk.

Finally, marginal risk can be used to calculate the risk of a portfolio over time. For example, a risk manager might track the marginal risk of a portfolio each month. If the marginal risk of the portfolio increases, the risk manager might take steps to reduce the risk of the portfolio.

Conclusion

Marginal risk is a valuable tool for risk managers. It can be used to help make decisions about which investments to add to or remove from a portfolio, to compare different investments, and to calculate the risk of a portfolio over time. By understanding marginal risk, risk managers can better manage the risk of their portfolios.