Loans and Risk Management: the Delicate Balance

Loans are one of the purest examples of risk management. The basic principle behind risk management in economics is: (Probability of achieving benefit x value of benefit) – (probability of achieving loss x cost of loss) Or in a more concise form: (P(B)xB)-(P(L)xL)

Where a risk is deemed worth it if the equation is equals something greater than 0. At zero it is considered a push, and most likely there are better uses for your money and time, whereas below zero the risk is greater than the reward. Loans fall into risk management when someone analyzes the potential cost not being to pay it off quickly. If ever driven by a loan service in Elmwood Park, IL, or any other town in the country, and wondered why people would take small loans with potentially huge interest, that’s why.

Liquidity has an inherent value, and sometimes money is needed instantly to pay for things. There is a risk usually in the form of high interest. Short term, small Loans typically fall into this category. People take them because they have a pressing need for the money and cannot delay on it. One classic example of this is the car repair. You cannot get to work if you can’t drive there, and arranging alternate transportation can be a bear. Another example is the medical or dental emergency, where a quick loan in Elmwood Park, IL is needed to cover an unexpected doctor’s visit or root canal. The benefit is then the value of having liquid or usable funds now minus the expense of the interest over time.

Larger Loans work on the same principle, that the risk of a missed payment and the know costs of interest are below the benefits of the immediate cash in hand. This is all the calculus of risk management, we see risk management constantly in other fields of life, be it business, government, military, or even sports. We do have a few tendencies that work against optimal strategies. Namely we tend to be risk adverse. This means that people have an inherent tendency to avoid risk to an irrational extent. We also combine this with confirmation bias so when we see a risk fail to pan out we treat it as evidence all risks fail. At the same time we fall victim to Bold Mover Bias meaning we ignore the calculus above if we view the potential pay out as being a really good thing. One of the purest forms of this bias can be seen in the reviews NFL teams get for drafting: “Sure they traded every draft pick for player X, but if he works out it’s worth it” that logic lets us excuse what should be a bad risk. What is the lesson to take away from all of this?

Be careful when you sit down and think about a Loan, if it works out to be in your interest take it, if you see that the risk outweighs the reward then don’t. This logic works just as well if you’re an investment banker in Zurich or a school teacher in Elmwood Park, IL.

 

Action Pawn and Loan is based in Franklin, IL, it offers quick Loans in Elmwood Park, IL and accept anything suitable as collateral. If you need quick money to take care of a sudden expense or if you’re just trying to get cash for gold and other old trinkets laying around the house, they can help you. Action pawn and Loan services the surrounding area including towns like Elmwood Park, IL and Bensenville, IL they can be found online or via phone at 847-288-9088

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