Capital risk is the process by which an investor in a business or other venture takes a certain amount of event risk with his or her funds. A person finances a proposal with capital and takes a chance that the proposal will either succeed or fail. This means that the venture can lose money or create a profit for the investor. The likelihood of loss or profit is often known as the risk-return tradeoff, a concept which measures the chances of the investment being a good one. Capital risk management is the process of attempting to assess the best decisions available for the investor.
In mathematical terms within the financial and business sector, capital risk can be assessed using specific statistical equations. These are used to evaluate concepts like event risk and relative risk when it comes to investing. Event risk is the factual hazard of placing money into some sort of investment. Relative risk is the chance that a person or business's exposure to certain conditions can create either a favorable or unfavorable situation. By using the mathematical equations that assess the past performances of the investment, present conditions and overall direction of the market, investors have a statistical probability of making good financial decisions.
One way an investor can hedge against potential losses in capital risk is to perform the process of locking in profit. Certain types of investments, often called options, allow a person or business to leverage a position against the risk of loss. Two types of options are the put and call options. Put options allow an investor to establish a capital investment in which he or she locks in trading prices when they choose to sell. Call options are the opposite, locking in prices for which he or she can purchase a financial security.
The most common example of capital risk is seed funding for a business. When a business starts up its operations, it requires a certain investment. This investment cannot always be supplied simply through loans from banks, but also requires investors who believe the business will make money. People and businesses supply a certain amount of funds to the business by purchasing stock within the company, which is expected to rise if the business succeeds or falls if the business fails. When this eventual situation develops, the concept of risk-return theory comes to fruition for the investor.