Political Risk, Terrorism and Kidnap & Ransom are very distinct and specific product lines? Describe the key components of all three. How do they dovetail? How are they different? What are the important underwriting components and does government involvement help maintain the market?

Answer:

Political Risk, Terrorism Risk, and Kidnap & Ransom Risk are three different types of risk faced by the investor. They have the ability to impact the market index and they can also impact the returns and risk of the stocks. These are three different risks and they are different ways to manage each and every risk. Let us first understand what these risks are all about.

Political Risk – This risk is faced by the investors and corporations as the policies of the government can impact the profitability of the business. In such a case, the earning per share can be hugely impacted. This risk could be specific to a business sector. In general, it can be concluded that the political risk is faced by the investors because of the changing governments or the changing policies.

The types of Political Risk includes

• Macro Level Political Risk – This is a countrywide political risk and that includes the change of government or failure of government.
• Micro-Level Political Risk – This component of risk includes the policies of the government. If the government is strict on diesel cars then this is a micro level political risk as it is going to impact a sector.

Components of Political Risk are

• Government Stability – Higher the government stability, lower the risk. This is always signified by a bullish stock market.
• Socio-economic conditions – If the socio-economic conditions are not good during a political era then the investor tends to lose faith in the market and hence the market is bearish
• Investment Profile – This has to do with the external politics of the government and the diplomatic ties with other countries.
• Internal Conflicts – Internal conflicts also have the power to impact the returns of the stock market and any civil war or protests can impact the returns in a negative war.
• External Conflicts – The external conflicts only includes war and another such scenario which causes stock markets to behave bearishly.

Terrorism Risk – Terrorism Risk is the risk faced by the investors and business because of the terrorist attacks. For example, an attack on the country causes a loss of property and business. The 9/11 attack itself was a major loss because of terrorism and the risk is really concentrated. This has a significant impact on the market and the markets can actually crash during any such terrorist attack.

Components of Terrorism Risk

• Threat – This is a key component of terrorism risk and the countries who are regularly threatened by the terrorist outfits are the key victims of the risk.
• Vulnerability – The investors also consider the vulnerability of the country and the area. It basically depends on the preparedness to deal with any such issues.
• Consequence – The consequences of the terrorist attack is the components of the terrorist. Higher the magnitude of damage, higher the risk

Kidnap & Ransom Risk – Another risk faced by the investor is the kidnap and ransom risk. If a prominent personality is kidnapped then the sector or the market could show the signs of loss. This loss can also be managed with help of insurances and other such tools. The key component of the risk is the threats faced and the ransom demanded. This can be dependent on the net worth and the status of the victim

How do these Risks Dovetail?

These risks dovetail as they all have the ability to impact the markets in a great way. These risks can be interdependent as well. If the government is not strong then it can possibly increase the terrorism risk and the political risk which would also increase the kidnap and ransom risk.

How are these Risks Different?

All these risks have a different factor that determines the magnitude of the risks. There are different ways to manage each risk and some of the countries also have derivatives which deal with these risks. Just like weather derivative, you can mitigate your risk with help of a similar derivative for political or terrorism risk.

Risks and Underwriting

Underwriting components can differ from one insurance provider to another but mostly, this is combined with several macroeconomic and microeconomic factor. The underwriting factors are can also be the components of these risk. These risks have different insurances available so as to tackle them efficiently.

Government Involvement and Damage Control

Talking about the involvement of the government and risk. The fact is that the involvement of government can certainly help in maintaining the markets but this is true to an extent. This can act as a damage control but if there is any event because of any such risk, the market is certainly going to show a bearish trend. Once the government takes the charge, the downward trend may continue or it may control the damage already done.

For example, in case of a terrorist attack, the markets are going to dive down but if the government takes the decision to declare a war on a nation then the market could react negatively as this would put a lot of business on risk. Hence, the decision of the government at the time of risk would determine the direction of the market.