Risk and reward values are calculated for many types of mechanisms. There are two types of values for risk and reward: margin and amount. These are most clearly displayed on the analysis tab of a trading program. Risk and Reward Margin is calculated at program line level. But how?
First, let's consider the concept of remaining forecast. This is the difference between your forecast transaction value and your actual transactions. As an example, suppose your actual spend is £16,500 for the year to date and your forecast value is £19,800. Then your remaining forecast would be £3,300. I.e. what remains of your forecast.
Risk margin is the percentage amount that your remaining forecast would have to decrease by to miss the band you are forecast to hit. Alternatively, you can think of this as the percentage likelihood that you will hit the band that you are forecasting at.
One point to note here, your risk margin can be above 100%. This only happens when you have already hit the band in which you are forecast to hit.
Reward Margin is calculated very similarly, it is the percentage amount that your remaining forecast would have to increase to hit the next band.
Risk Amount is a connected concept to risk margin. The risk amount is the amount of rebate that would be lost if you were to just miss the target band which you are forecast to hit compared to the rebate earned at your forecast.
Reward Amount is again very similar to the risk amount. The reward amount is the amount of rebate that would be earned if the next target band was reached compared to the rebate earned at your forecast.
Let’s use a case study to give an example of how this is calculated:
Suppose we have a tiered program line with the following tiers:
Now suppose we have the following transactions in the system:
The Analysis tab would look as follows:
Now lets explain these figures:
Risk Margin and Amount
The actual transactions for this line are £16,500 and we have a forecast of £19,800. This gives us a remaining forecast of £3,300. The risk margin here is 84.9% as the remaining forecast (£3,300) would need to decrease by 84.9%, for us to not hit the £17,000 band.
£17,000 is £2,800 less than £19,800. So the risk margin is £2,800/£3,300 * 100 = 84.9% (1.d.p).
The risk amount here is £226 = £396 (=£19,800 * 2%) - £170 (=£16,999.99 * 1%).
Reward Margin and Amount
The forecast for this program line is £19,800. The next target band is reached at £20,000. The reward margin is simply the percentage amount the remaining forecast would have to increase to hit this next band. In this case, it's what percentage does £3,300 need to increase for us to hit £20,000 overall. So, the reward margin is £200 (= £20,000 - £19,800) / £3,300 * 100 = 6.1% (1.d.p).
The reward amount here is £204 = £600 (=£20,000 * 3%) - £396 (=£19,800 * 2%).
You can learn more about risks and rewards in the Watchlist App.