Financial Risk Management For Dummies

Chapter 10

Setting Limits

In This Chapter

Understanding limits

Setting up your system

Monitoring your limits and your system

Nothing says aggressive financial risk manager better than limits. Limits on everything – leverage, cash levels, stress losses – you name it, a risk manager somewhere has put a limit on it. When limits fail to prevent a disaster, the answer is … more limits!

Of course, limits are one of the key tools of financial risk management. They can prevent build-up of unsustainable levels of risk, and help keep risk distributed according to plan. But mindlessly placing limits can put straitjackets on risk takers, not only impairing their ability to make profits but increasing risk as well. In this chapter, I show you how to design a sensible set of limits to keep the risk taking robust, disciplined and productive.

Describing Basic Limits

Anthropologist Franz Boas famously observed that Eskimos have dozens of words for snow. The idea that the number of words a culture uses for a concept is proportional to the importance of the concept turns out to be a fascinating half-truth and a starting point for useful investigation of anthropological linguistics. I mention the idea ...