## Risk and Exposure

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Risk is the chance that a possible negative event actually will occur. In investing, this means the chance adverse events will cause you to lose money. For example, if you purchase a bond, there is some probability that the bond issuer will default, leaving you out of luck and out of money. A risk exposure calculation tells you how much you are likely to lose due to adverse events.

## Estimating Risk Probability

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Before you can calculate risk exposure, you need a reasonable estimate of the probability a risk event will occur. Suppose you are considering investing in a corporate bond. Do some research to find the default risk of the bond. For example, during the early 2000s, corporate bonds rated as investment grade by Moody's had a historical default rate of 2.09 percent. Non-investment grade corporate bonds defaulted at a whopping 31.37 percent rate. You can find comparable data for other events, like the odds a startup will fail or commercial real estate will fall in value, by using financial publications or government sources, or by asking your broker for assistance.

## Risk Exposure Formula

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The formula for calculating risk exposure is the total loss if the risk occurs multiplied by the probability that the risk will actually happen. Suppose you plan to purchase $10,000 worth of investment grade corporate bonds. If the issuer defaults, your loss could amount to the entire $10,000. If the default risk is 2.09 percent, multiplying $10,000 by .0209 gives you a risk exposure of $209.

## Evaluating Risk Exposure

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Using risk exposure as an investment guide requires some judicious interpretation. For example, an investment with high risk and a low potential loss can yield the same exposure as a low-risk investment with the possibility of a large loss. Another issue to consider is the expected return on the investment. You'll need to make a judgment call as to whether or not the risk exposure is acceptable given the potential profit.