Syllabus

No. of
No. Modules/ Units
Lectures
1
Introductionto RiskManagement: 15
The Concept of Risk, Identification of Risk faced by
Organization
Risk and Uncertainty, Strategic and Operational Risks
Dynamic Nature of Risks
Business Risk
Financial Risk faced by Organization
Objectives of Risks Management
Process of Risk Management
2 Evaluation of Risk:
15
Evaluation of Organization's ability to bear them
Risk Measurement
Sources and Impact of Common
Business Risk Market,
Credit, Liquidity, Technological, Legal
Reputation, Country Risk Environmental,
ldentify and assess the impact upon the
involved in Business Risk stakeholder
Nature and
Importance of Financial Risk,
Evaluation of
Financial Risk, Evaluation of Alternative Risk
Management Tools
Role of Risk Manager and Risk Committee in
identifying
and managing risk
3
Foreign Exchange Risk:
Forex Market 15

Identifying and Analyzing Forex Risk

4
Managing Forex Risk
Exchange Rate Risk:
Interest Rate Market and 15
Mathematics
ldentifying and Analyzing Interest Rate Risk
Measuring Interest Rate Risk
Total
60

(v)
 Question Paper Pattern
CONTENTS
Maximum Marks: 75
Duration: 2% Hrs.
Questions to be Set: 05
15 Marks each.
All Questions are Compulsory Carrying No. Chapter Pages
Q-1 Objective Questions 15Marks
to be asked 10 and to
be answered any 08
(A) Sub Questions and to be answered any 07
to be asked 10
(B) Sub Questions
False / Match the columns, Fill in MODULE-1
("Multiple choice/True
or

the blanks)
15 Marks 1-16
Q-2 Full Length Question 1. Introduction to Risk Management
OR
15 Marks 2. Business and Financial Risk 17-31
Q-2 Full Length Question
Q-3 Full Length Question 15Marks
OR
MODULE II
Q-3 Full Length Question 15 Marks

Q4 Full Length Question 15 Marks3. |Evaluation of Risk 32-41

OR
15 Marks
4. Risk Measurement 42-61
Q4 Full Length Question

Q-5 (A) Theory questions 08 Marks

5. Sources and Impact of Common Business Risk 62-79
(B) Theory questions 07 Marks
OR

Q-5 Short Notes: 15 Marks

6. Alternative Investment Strategies 80-97
To be asked 05
To be answered 03
MODULE

Note: Full length question of 15 marks may be divided into two sub questions 7. Foreign Exchange Market
of 8/7 and 10/5 marks. 98-110

8. Foreign Exchange Risk 111-132

(vi) (vii)
 Introduction to Risk Management

Chapter Pages MODULE - I

No.

MODULE - IV
Chapter |
9. Interest Rate Market 133-153

10. Bond Mathematics 154-173 Introduction to Risk

11. Interest Rate Risk 174-191 Management
12. Case Studies 192-208
I. Introduction
1.2 Identification of Risk Faced by Organization
1.3 Risk and Uncertainty
Model Question Paper 209-211
1.4
I.4 Strategic and Operational Risks
I.5 Dynamic Nature of Risks
1.6 Objectives of Risk Management
I.7 Process of Risk
Management
I.8 Solved Problems
1.9 Practice Problem
1.10 Questions

(viii)
 Vipul'sTM Risk Managemet
to Risk Management 3
Introduction

1.1 INTRODUCTION: Returns

Risk is defined
as volatility of
actual
turns irom a
returns

with respect to
expected returns. More
investment

is risk associated
with investme. volatie
returns are, higher
Return have dre Capital Gains
Risk and Return: Risk and
have Dividends/Interest
other. Higher is the risk
relationship with each for To understand this let us consider following examples.
investment, more will be
the expected returns from it
Example 1:
An investor brought a share of ABC Ltd. at Rs. 100/-
After a year investor sold the share at Rs. 110/- Dividend
received by the investor during the period is Rs. 5/-
RETURNS Calculate Returns earned by the Investor.

Solution:

Return_I+ (P1- P2)

P2

Dividend received is Rs. 5/- Capital gains for the Investor

RISK is Rs. 10/- (110-100).

Fig. 1.1:
5 00
Therefore, Rate of Return (R) = 1 .15
100
As seen from above diagram, as Risk increases expected
Hence, Rate of Return (R) for Investor is 15% (Returns
Returns from Investment also increases.
expressed in percentage).
RETURNS:
Example 2:
Return refers to gain expected by investor fro An Investor invested in bond of XYZ Ltd. Coupon of bond
VGSUment made
by him. Return broadlv comprises of two is 10%. After a year bond will redeem at face value of
disd regular income which is in form o Rs. 100/-. Investor bought bond at a discount of 10% to
dividends interest. Second is in form
or
of capital face value. Calculate Returns of investor?
Rate of Return
gains
(R) (P]-
P2
P2)
=
Solution
Where, I Return =tPI-P2)
=
Cash flow in P2
form of dividends or erest
P) =
Price of the Intc Interest received is Rs. 10/- Capital gains to investor is
period
security at the end
end o
of holding
Rs. 10/- (100-90).
P2
Purchase price of
security.
 Vipul'sM Risk Management (8
Introduction to Risk Management
10 +
ofReturn (R)
=

90
=
0.2222 of whether not such risks are within the direct
Therefore,
Rate
regardless or

for Investor is control of the organization. Organization should adopt a

Rate of
Return (R) 22.22%
22%
Hence,
percentage. severe and on-going process of risk identification that also
expressed in
(Returns are
includes mechanisms to identify new and emerging risks on

timely basis.
OF RISK FACED B
1.2
IDENTIFICATION
Risk identification should be inclusive and should not
ORGANIZATION:
excessively rely on the inputs of a few senior officials and
is the process ot determining ris
sks
Risk identification
the program,
tng ks
enterprise
should also draw as much possible on unbiased
as

that could potentially prevent oindependent sources, including the perspectives of

investment from achieving its objectives. It includes important stakeholders.
the concern.
documenting and communicating Risk identification should be strengthened by
by
identification is the early and
The objective of risk supplementing Management's views of risks, along with:
if occur, will have
continuous identification of events that, Review of external and internal audit reports:
negative impacts project's ability to achieve
on the
Review of the reports of the standing committee on
performance or capability outcome goals. They may come public accounts and the relevant parliamentary
from within the project or from external sources.
committee(s).
Risk identification needs to match the type of
ype Financial analyses.
assessment required to support risk-informed decision
Historic data analyses.
making. Actual loss data.
Risk identification is a systematic efiort
careful and
Interrogation of trends in key performance
identify and document the organization's key risks. 1he indicators.
objective of risk identification is to understand what is at
risk within the context of the Benchmarking against peer group or quasi peer
organization's clear a
implied objectives and to generate a complete pictu e group.
risks based on the threats and vent, Market and sector information.
events that might pio
degrade delay the achievement of the
or Scenario analyses and.
objectives.
Comprehensive identification and recordingg of
ot risk
Forecasting and stress testing.
critical, because a risk that is not
i> have

critical identified may

impact. In
order to manage risks effectivey 1.3 RISK AND UNCERTAINTY:
organisations have to know what risks with

The risk identification they are faced w

a l l risks
In the ordinary sense, the risk is the outcome of an
process should cover all action taken or not taken, in a particular situation which
 7
Vipul'sM Risk Management (R
(BFMIntroduction to Risk Management

Rrsue.
chanca O P E R A T I O N A L , RISKS:
OPERATIONAL
termed as a S T R A T E G I C AND
STRATEGIC
result in loss or gain. lt 1s

ev. lo1.4
1.
may out of internal or exte 1.4.1 Strategic Risk:
to danger, arising
or exposure
can be
minimised
through prevente Strategic Risk is defined
a s possible s o u r c e of
loss that
tactors, that
unsuccessful business
the pursuit of
Irom the
a n
might arise from
anse
measures.
the absen. gnt risk might arise from making
o plan. For example, strategic
we mean

By the term uncertainty, cence substandard execution of

is business decisions, from the
not k n o w n . . lt reters to
inty or something which a poor
r e s o u r c e allocation, or from a
situation where there
are mulupie
auiilaVS
Tesulting in decisions, from inadequate
in the business
a outcome, but the probability oI
specific
the
outcome is not failure to respond well to changes
certain. This is because of
insufficient information or environment.
condition. Hence, it is hard t As organization attempts to achieve their strategic
knowledge about the present
an

future outcome or'events. both internal and external events and scenarios
define or predict the objectives,
is given in can inhibit prevent a n organization from achieving their
or
Comparison between risk and uncertainty
table below:
strategic objectives. This is called a s strategic risk.
Strategic risk c a n be further defined as:

BASIS FOR RISK UNCERTAINTY

Exposure to loss resulting from a strategy that turms
cOMPARISON
out to be defective or inaPpropriate.
Meaning: The probability of |Uncertainty implies a Risk associated with future plans and strategies,
winning or losing situation where the future
including plans for entering new services, expanding
something worthy is events are not known.
existing services through enhancement and mergers,
known as risk. enhancing infrastructure, etc.
Ascertainment: It can be measured t cannot be measured. Current and prospective impact of strategic decisions
made by management arising from adverse business
Outcome Chances of outcomes The outcome is unknow decisions, improper implementation of decisions or lack
are known.
of responsiveness to industry changes.
Control: Controllable Uncontrollable. Common sources of Strategic Risk is shown in figure 1.2
Minimization: Yes. below:
No.
Probabilities: Common Strategic Risks
Assigned. Not assigned. External Risks: Human Resource Risks:
Competition Knowledge
Market changes Staffing
Employee theft
 Vipul'sTM Ris
Management 4 Introduction to
Risk Management
9

Structural Resource Risk environmental

pending legal issues,
Financial Risk:
IT systems from financial frauds, which
risk is much wider concept
Cash flow issues etc. Operational
Proprietary
Proprietary informatin
information failed internal
includes every risk that arises from
Capital Regulatory actions
a n organization
or failure of people working
Price or cost pressures
processes of
Physical Resource Risks:
Relationship Risks:
with organization.
Reputation business are
be reduced if operations of
a
.Disasters Such risk can
Vendor performance its
Bottlenecks properly insured. Also business should diversify
associated with
Figure 1.2 investment to reduce unsystematic risk

risks is: investments.

A useful subdivision of strategic risk is legal risk. As
that derive from the decisin Most commonly known operational
Business risks: Risks that
risk is a type of risk which m e a n s
about the products or servio per Wikipedia legal
that the board takes able to enter into a contract.
include counterparty is not legally
that the organisation supplies. They risk
risk i.e. that a
Another legal risk relates to regulatory
associated with developing and marketing th policy or m o r e
transaction could conflict with a regulator's
economic risks affecting produ
products or services,
8enerally that legislation might change
during the life of a
sales and costs, and risks arising from changes in t
of techniques used
Some. of
i n a n c l a l contract. Some
financial
used to o v e r c o m e
environment which impact on sales an
technological legal risk are:
production. audit.
(1) Conducting legal
Non-business risks: Risks that do not derive from th
(2) Communicating educating people associated
and
products or services supplied. For example, s
with business significance of legal compliances.
associated with the of finance us
long-term sources

Strategic risk levels link in with how the wna (3) Having strong compliance and governance policies.
(4) Employing experienced and qualified legal
resources.

organisation is positioned in relation to its environ

and are not affected solely by what the directors deci Operations of stock exchanges:
Competitor actions odud
settlement is one of the most important
will affect risk levels in pr Clearing and
worldwide. With
markets, and technological developments may operations carried out by stock exchanges
mea

thatproduction processes, or products, quickly beceffect from April 1, rolling settlement has been
2003 T+2
o n T day,
out-of-date. introduced. In T+2 settlement trading takes place
1.4.2 Operational Risk: on T+1 day confirmation of
trades takes place and on T+2

and out (of both securities as well as funds)

An
operational risk is risk that arises from functioning day pay in Following
pay
table summarizes time schedule of
ttakes place.
an
organization. This risk includes failure of syst

or
processes of an organization. people, T+2 rolling settlement.
It also includes
ri
 Vipul'sM Risk Managem
10
11
Description of activity Introduction to Risk Management
Day
DYNAMIC NATURE OF RISKS:
1.5
T Trade day a large extent. Risk, on the
Confirmation of all trades takes place (bv Risk issues a r e not static to
in nature. It is
T+1
00 other hand, is not affixed or stationary
am. based and hence volatile in nature. Most risks
probability are
identified in the risk management process
T+2 Pay-in of securities and funds. that are

dynamic in nature.
Pay-out of securities and funds. of
Some of the factors which have
created high degree
In T+2 settlement trades are executea on l day. Clean 11ncertainty in the economy are:
takes place on T+1 day which means obligations
a the Internet.
Technology and
determined on T+1 day. On T+2 day final settlementi
Increased worldwide competition.
delivery of funds and securities takes place.
Freer trade and investment worldwide.
Advantages of T+2 rolling settlement:
financial instruments, such as derivatives.
(a Reduces speculation and Complex
helps in better prio
Deregulation of key industries.
discovery.
(b) Reduced settlement period. Once trade has bee Changes in organizational structures resulting from
downsizing, reengineering, and mergers.
executed, final settlement i.e. pay in and pay
Out and
funds and securities takes Higher customer expectations for products
place after 2 days.
(c) Rolling settlement have services.
made
trading cycle undo
across all stock The international business world has been changing
exchanges country.
in
Risk associated with dramatically that, peopleface a variety of risk almost
settlement: unimaginable from a decade or 2 ago. We need to adopt
onterparty risk: This risk arises when one pa various techniques to identify risk, and once
by
ails to fulfil its obligation. This risk can be elimina process of identification 1denuLca
should be dynamic
and
by delivery v/s payment
delivery against payment. mechanism which ensure continuous.
(b) System Risk:
of operational,1 1.6
and
systemic comprises
risks. To
OBJECTIvES OF RISK MANAGEMENT:

exchanges have enforced eliminate this risk st

risk stod
Managing risk refers to identification, assessment, and
standards, maintaining
standards, maintaini margin
nargin and capital adequ
capital aprioritization of risks followed by coordinated and
settlement
c n e n t guarantee funds
guarantee i
funds ete
economical application of resources to minimize, monitor,
and control the happening of untortunate events or to

maximize the returns from opportunities. In ideal risk

 Vipul'sT Risk Management is to Risk Management 13
8 Introduction

management,
prioritization process
a
is followed L owed whereb The process is explained in figure 1.3.
loss (or impact) and the greas
the risks with the greatest
of occurring are
handled first, and risko
reates Identification||Analysis
risks wit
Evaluation Treatment| Monitoring|
probability
and lower loss are ha Fig.: 1.33
lower probability of occurrence
dle
in descending order. In practice the process of asses Identify the Risk: First step is to uncover, recogrnize
overall risk can be difficult, and balancng resources use and describe risks that might affect your project or its
se
to diminish between risks with a high probability outcomes. This risk could be market risk, unsystematic
occurrence but lower loss versus a risk with
high loss bu risk, political risk or any other risk which may impact
lower probability of occurrence can often be mishandled. the working of the organization.
Some common objectives of Risk Management are: Analyse the risk: Once risks are identified we need to
Develop a common understanding of risk acros determine the likelihood and consequence of each risk.
multiple functions and business units so we ca We than need to develop an understanding of the
risk cost-effectively nature of the risk and its potential to affect project
manage on an
enterprise-wid
basis. goals and objectives.

Achieve better Evaluate or Rank the Risk: Next step involves

a
understanding of risk for competitive
advantage. evaluating or ranking the risk by determining the risk
Build magnitude, which is the combination of likelihood and
safeguards against earnings-related surprises.
Build and improve consequence.
capabilities to respond effectively to Treat the Risk: This is also referred to as Risk
low probability,
critical, catastrophic risks.
Achieve cost Response Planning. This step involves assessing the
savings through better management o highest ranked risks and set out a plan to treat or
internal resources.
modify these risks to achieve acceptable risk levels.
Allocate capital more efficiently. This involves creating risk
mitigation strategies,
preventive plans and contingency plans.
1.7 PROoCESS OF RISK Monitor and Review the risk: This
All risk MANAGEMENT: step involves
management processes follow the same
steps, although
monitoring, tracking and reviewing the risk. Once
sometimes different Da reviewing is completed necessary corrective actions may
describe these terminology ed t
is usea be initiated.
steps.
process steps combine Together these 5 risk
a simple and manage
ment

to deliver
management process. effective ris
effectv

t
 vipul'sM Risk Management (a
Introduction to Risk Management
15
1.8 sOLVED PROBLEMS:
Solution:
lustration 1.1:
t ( P 1 - P2)
An investor bought 20 shares of ABC Ltd., at Rs.
150 pe
Return =

P2
sold the same at Rs. 200 per
share. After 2 years he
200. He also
shan Where,
dividend Rs.
During the period he earned, also pai Interest
broker. Calculate Paetun I =
Cash flow in form of dividends or
commission of Rs. 200 to the
P1 Price of the security at the end of holding period
earned by the investor.
P2 Purchase price of security.
Solution:
Dividend received is Rs. 50 Capital gains for the Investor
P1 P2)
Return =

are Rs. 50 (150 - 100).

P2
Where,
Therefore, Rate of Return (R) 50+ 500 -
1
1
00
I= Cash flow in form of dividends or Interest
Hence, Rate of Return (R) for Investor is 100% (Returns
Pl = Price of the security at the end of holding period
are expressed in percentage).
P2 Purchase price ofsecurity. I1lustration 1.3:
In this case, I 200
Mr. Ajay purchased 500 shares of ABC Co. Ltd., on 1st
P1 200 x 20 = 40000
January, 2012 at Rs. 150 per share. He sold the shares on
P2 15 x 20 3000 1st January 2013 Rs. 160 per share. He paid brokerage
at
Rs. 500 to the agent. He received Rs. 1,000 as dividend.
Additionally client had paid commission 200 to of Rs.
broker which needs to be deducted from total gain tind out his capital gain.
thof
investor Solution

Hence Return =200+(4000-3000) -200 Return +Pl-P2)

3000 P2
= 0.3333
Where,
Hence, Rate of Return I= Cash flow in form of dividends or Interest
(R) for Investor is 33.33% (Retur
are
expressed in percentage). Pl =
Price of the security at the end of holding period
11lustration 1.2: P2 Purchase price of security.
An investor
Rs.
bought 10 shares of ABC Ltd a In this case, I =
1,000
100/share.
After 2 Same a P1 160 500 80,000
150/share. During theyears he sold the sa
= x
Rs.
Rs. 50/share. period he earned dividen P2 150 x
500 75,000
Calculate return earned
by the investor
 Vipul'sM Risk Management (8F 11
Financial Risk
Business and

client had paid

commission
of Rs. 500 to th
Additionally from total
deducted

broker which
needs to be gain
Chapter 2
investor.

1.9 PRACTICE PROBLEMS:

Financial Risk
(1) Mr. Singh purchased
500 shares of XYZ Co. Ltd., onBusiness and
Rs. 250 per share. He sold the shar.
January, 2012 at
on 1st January 2013 at Rs. l60 per share. He pa

brokerage of Rs. 300

to the agent. He receive 2.1 Definition of Financial Risk

Rs. 1,500 as dividend.

Find out his capital gain. 2.2 Nature/Types of Financial Risk

An investor bought 20 shares of Best Ltd a 2.3 Importance of Financial Risk

(2)
2.4 Various Methods to Evaluate Financial Risk
Rs. 100/share. After 2 years he sold the same
Rs. 180/share. During the period he earned dividen 2.5 Managing Financial Risk

Rs. 70/share. Calculate return earned by the investor. 2.6 Definition of Business Risk

2.7 Managing Business Risk

2.8 Comparing Financial Risk and Business Risk

1.10 QUESTIONS:
2.9 Questions
(1) Define risk and returns.

(2) Write a note on "ldentification of Risk faced by Organization"

(3) Discuss Risk and Uncertainty.
(4) Explain Strategic and Operational Risks.
(5) Explain Dynamic Nature of Risks.
 Risk
19
Vipul'sTM Risk Management (Re, Financial
Rusiness and
1S
RISK: perspective is provided by separating financial risk into four
2.1 DEFINITION OF FINANCIAL market risk, credit risk, liquidity risk and
broad categories:
Finaneial Risk: operational risk.
risk is related to the compan.. involves the
risk involves
Market risk risk of
the risk of changing
changing
A company's financial ny tal
(a) Market Risk: Market
use of financial leverage
and debt financing,inancing, rat
rathe conditions in the specific marketplace
in which a
the
than the operational risk of making companv
company
for
competes business. There could be
risk is concerned with risk such a s change
profitable enterprise. Financial number of factors behind market
company's ability to generate sufficient cash flow to b in expectations, availability
in c o n s u m e r taste, change
able to make interest payments on financing or meer substitute etc.
of a cheap or superior
other debt-related obligations. Obviously, a compan
(b) Credit Risk: Credit risk is the risk businesses incur by
with a relatively higher level of debt financing carries It also refer to the
extending credit to customers. can
higher level of financial risk, since there is a greater
company's own risk
creditsuppliers. A business
with
possibility of the company not being able to meet its
takes a financial risk when it provides financing of
financial obligations and becoming insolvent.
purchases to its customers, due to the possibility that a
Some of the factors that may affect a company's customer may default on payment.
are interest rate changes and the overal
financial risk
(e) Liquidity Risk: Liquidity risk includes asset liquidity
percentage of its debt financing. Companies with and operational funding liquidity risk. Asset liquidity
greater amounts of equity financing are in a better refers to the relative ease with which a company can
position to handle their debt burden. One of the convert its assets into cash should there be a sudden,
primary financial risk ratios that analysts and investors substantial need for additional cash flow. Operational
consider to determine a company's financial soundness
funding liquidity is a reference to daily cash flow.
is the debt/equity ratio, which measures the relative General or seasonal downturns in revenue can present
percentage of debt and equity financing a substantial risk if the company suddenly finds itself
Foreign currency exchange rate risk is a part of the without enough cash on hand to pay the basic
overall financial risk for expenses necessary to continue functioning as a
companies that do a
substantial amount of business in business.
foreign countries.
(d) Operational Risk: Operational risks refer to the
2.2
NATURE/TYPES OF FINANCIAL RISK: various risks that can arise from a company's ordinary
Financial risk is any of business activities. The operational1 risk category
various types of risk
with financing, including financial associa includes lawsuits, fraud risk, personnel problems and
company loans in risk
transactions that incu business model risk, which is the risk that a company's
of default. There are to
categorize a many way
company's financial risks. One p o s s i b l e
poss
 iqul'sTM Risk Management (B
20 Business and
Financial Risk 21
and growth plans may prove to b
models of marketing CRA's required to be registered with appropriate
are
inaccurate or inadequate. take into consideration
regulator (SEBI in India). CRA's
factors like financial performance of firm, track
various
RISK: default record of firm
IMPORTANCE OF FINANCIAL record of promoters of firm, past
2.3
2.3
Financial risk is the possibility that shareholders w etc.
lose money when they invest in a company that ha Following table shows example of rating assigned by
debt, if the company's cash flow proves inadequate t CRA's:
obligations. When a company Ise
meet its financial Description
Credit Ranking/Risk
financing, its creditors are repaidbefore
debt
shareholders if the company becomes insolvent itRating
S
level

Financial risk also refers to the possibility of AAA 1/Minimal Firm have excellent debt repaying
corporation or government defaulting on its bond capacity. Firm is very strong
fundamentally and have no default
which would cause those bondholders to lose money.
term for many history.
Financial risk is the general differen
types of risks related to the finance industry. Thes AA 2/Moderate Firm have good debt repaying
include risks involving financial transactions such u| capacity.
company loans, and its exposure to loan default. Th A 3/Average Firm is of average size and have
term is typically used to reflect an investor average debt repaying capacity.
uncertainty of collecting returns and the potential fo
BBB 4/Acceptable Firm may not be able to sustain
monetary loss.
major setbacks. Firm have asset
quality of acceptable standards
2.4 VARIOUS METHODS TO EVALUATE
FINANCIA which are less than average.
RISK:
BB 5/Acceptable Firm have considerable risk
Various techniques used for measurement of credit ris
are as follows:
with care associated with it. In-depth analysis|
must be done by investor before|
Credit rating: Credit rating is of the most investing in company.
used
one
wu
techniques to determine
borrower. Banks and
other lending
the
creditworthinesuse B 6/Management | Continuous attention towards firms
credit rating institution attention performance and financial position is
assigned to borrower to analysc deb necessary for lender investor.
repaying capacity of borrower. ratings a
or

assigned to firms by Credit Credit ratings

Rating Agencies (CRA
 Vipul'sM Risk Management 23
Financial Risk
Business
and
22
evaluate cycle risk

CCC
8/Substandard Firm in

Insufficient
poor

net
financia
worth
posit Hence
related
it is very
to borrower
necessary
especially
to

of cycle-dependent
and
repaying capacity. industries.

Usually in Expert System

a weight is assigned to
Firm in extremel
poor and accordingly credit
CC
9/Doubtful
financ
position. High probability th each factor (decided by
lender)

will default.
that risk of borrower is
calculated.

efficient tool to
Analysis: Leverage ratios
are an
Ratio
Total loss for nvestors as
firm ha m e a s u r e long term
financial strength or soundness of a
D 10/Loss
debt of a firm to pay
little or no repaying capacity firm. These ratios determine ability
dates.
interest on time and repay principal on due
This system requires analvsin
Expert system: Various leverage ratios used to judge long term
to borrower. These 5 Cs are
Cs of credit related solvency of a firm are:
of reputation of fm
(a) Character: It is
a measure

(a) Debt-Equity ratio

=
Debt/Equity
takes into consideration past repayment record
This ratio reflects relative contribution of creditors
borrower.
and owners to finance the business.
(b) Capital: It refers to ratio of own fund to borow Debt-Asset ratio =
Total Debt/Total Assets
fund. It helps lender to determine probability (b)
Here debt comprises of long term debt plus current
borrower going bankrupt.
liabilities.
(c) Capacity: It refers to ability of a firm to repay i
(c) Interest Coverage Ratio (ICR) =
Earnings before
borrowings. Higher is volatility of earnings fr
Interest and Tax/Interest
firm more will be risk associated with firm.
This ratio indicates firm's ability to fulfil its interest
(4) Collateral: It refers to asset pledged by borrower
paying ability.
borrowing funds. Higher is market value is ICR better is of firm to fulfil its
collateral lower will be credit risk. Higher ability
interest obligations.
(e) Cycle
(Economic Risk): There are Certa

(d) Debt Service Coverage Ratio (DSCR)

industries which follow
oror
certain cycle.
a PATDeprication + Other non cash expense+
Cement Whe

industry will grow at high

ra
e
Repayment of term loans +Interst on term loansS
economy develops because with econo Interest on term loans + Repayment of term loans

developments there is increase in in infrastruc DSCR is a better measure to determine the debt
and hence
demand for cement repaying capacity of a firm.
Same is not the case when economic growth slb increa
down
 Vipul Risk
Risk Managemem

24
FINANCAL RISK: Financial Risk
25
usiness and
MANAGING

2.5
2.5
financial risk requires different
differ methon Trading in exchange traded products: Trading in
Different Cth() liquidity to
exchange traded products give
more

mitigation.
to those which traded
Market Risk:
One ot most widely ed techniqe
used
investors as compared are

(a) portfolio ol
eliminate this
risk is to make
global
various co11nt
a
One over the counter.

risk c a n be reduced if
n.c)Operational Risk: Operational
securities irom
introducing ntnies insured. Also
diluted. Similarlu operations of a business are properly
risk of portfolio can be
can manage market risk by diversifying their reduce
business should diversify its investment to
prod associated with investments.
and market. Also organization
need to unsystematic risk
update
marketingstrategies to overcome this risk. d) Credit Risk: TECHNIQUES TO HEDGE CREDIT RISK:

pricing: This technique involves

(b) Liquidity Risk: Some commonly known techniiques () Risk-based

deciding interest rates on case to case basis. Those

manage liquidity risk
are:

borrowers which have higher probability of

(4) Storing liquidity: This is most basic solutin
defaulting are charged with higher rate of interest.
managing liquidity risk as it suggests keti
This technique requires lender to consider various
certain amount of money as cash reserves. Thise
facts related to borrower like loan purpose, credit
be done by allocating a certain amount of
fi rating, leverage ratios etc.
money to money market investments.
(id) Use of derivatives: Lenders and bond holders can
(i) Liquidity Insurance: Purchasing a liqut hedge risk through credit insurance or credit
insurance means
entering into an agreement derivatives. These contracts transfer the risk from
another party to
provide cash at a predetermn lender to the seller (insurer) in exchange for
rate when required.
payment. Most commonly known credit derivatives
(in)Limiting exposure to
illiquid securities: are Credit Default Swap (CDS) and Total Return
Simple solution to Swap (TRS).
manage liquidity risk 1s
exposure to illiquid Credit Default
securities. It is necessayaryt Swap is like buying credit
investor or
fund insurance. Here lender pays fixed amount
investment made managers
in
must set a cap
assets to re of CDS who is also known
to seller

illiquidity of portfolio illiquid assets insurer. If borrower

does not default, lender will receive
as

iv) nothing from

Investing in open
ended
insurer. However if borrower defaults, insurer will
investors invest a funds: It
necess

that 16
have to cover the default loss and make
payment to
ended funds.substanua
amoun

money in open lender.

 Vipul'sM Risk Management
TT
26 Financial Risk
27
summarises CDs. usiness
and

Following figure
summarises TRS:
Following figure
Fix rate +Change
Premiumn In market values
of Loan

Insurer or
Lender CDS seller Insurer or
Lender TRS seller

Payment only if
Borrower defaults
Floating rate
(MIBOR)

Total Return Swap: TRS is an agreement

counterparty (TRS sellet (iii) Diversification: Lending to small number of
lender agrees to pay
annual rate plus change in market value of borrowers can increase credit risk. To reduce credit
loan. In return lender will receive risk, lending institutions should diversify investor
a
floating a pool and should increase the number of people to
Thus it provides protection to lender in cas
whom credit is given.
increase in credit risk of borrower.
Assume that par value of a loan is 100. At (iv) Covenants: Lenders may write conditions on the

beginning of swap period value of loan is same borrower, called covenants into loan agreement.
Some of these are:
par value i.e. F100 but after a year credit ris
borrower increases and hence value of loan Periodically report its financial conditions.
to 90.
red
Assuming fix rate to be paid by lende" Restrict borrower from paying dividends,
TRS seller
is 12%. Now payment to be mau repurchasing shares, further borrowings or any
lender to TRS seller will be action which have
12-10(as value of negative impact on
has reduced company's financial performance.
by 10%). Hence lender pays
TRS seller. On oniy
the other hand
seller pays
AIBOX Repayment of loan at request of lender if there
lender which we is
10%. He change in borrower's Debt Service Coverage
lender receives assume is around Ratio (DSCR) and Interest
10% only Coverage Ratio (ICR)
Therefore, total gains to whereas pays
pays
lender is 80.
.6 DEFINITION OF BUSINESS RISK:
Business risk refers to the basic
sustainability of a
business,the question of whether a
able to make
company will be
sufficient sales and generate sufficient
 Vipul Risk
Management ( Financial Risk 29
28 Business and

to cover its operational

expenses and
and tum2.1 MANAGING
MANAGING BUSINESS RISK:
BUSINESs RISK:
revenues

risk is
c o n c e r n e d with
the 2.7
profit. While financial be managed in following ways:
i s concerned with all Business Risk can
business risk
of financing, business plan: The process of writing and
expenses a business s t
Cov to
rem. (1) Write a
other is vital step to
These expenses in
putting together plan a business a

operational and
functioning. nclu
costs, tacility rent, and office a assessing, evaluating and planning for the risks of
salaries, production business from the various standpoints of the
administrative expenses.
running a

business. This includes operations, finance and

The level of a company's business risk is influenced
marketing.
factors such as its cost of goods, profit mari
Determine insurance needs and obtain coverage:
competition, and the overall
level of demand for 2)
Most businesses carry liability insurance or insure the
products or services that it sells.
building and contents where the business operates.
Business risk is often categorized into systematic
Depending on the business activities, we need to
and unsystematic risk. Systematic risk refers to t
determine the other types of insurance and obtain the
general level of risk associated with any busine correct coverage for the business.
enterprise, the basic risk resulting Irom Iuctuati
(3) Write a risk management plan: Separate from our
economic, political and market conditions. Systemat business plan, we need to write a risk management
risk is an inherent business risk that compani plan, which lists all of the possible risks that can affect
usualy have little control over, other than their abill the business. The plan also lists the
steps, procedures
anticipate and react to changing conditions.
to
and ways in which the business intends on
dealing with
Unsystematic risk, however, refers to the risks relat the risk as it arises
to the specific business in
which a company is engage (4) Train employees: Providing training to employees
A
company can reduce its level of
through good management decisions
unsystematic about ways to avoid risks and how to deal with the risk
if it occurs can help the business avoid
expenses, investments and
regarding cos further damage
Operau
marketing. Operatin exposing itself to risk in the first place
or
everage and free cash flow
use to
are measures that invest(5) Update plans: Even the best of planning efforts may
assess a
company's operational eficie fall
short, when the business is exposed to a risk,
so
management of financial resources. react accordingly and then
put a formal plan and
procedure in place in case the same risk occurrence
happens again.
 Vipul'sM Risk Management ( and Financial Risk 31
30 Business

AND Btis
2.8 COMPARING
FINANCIAL
RISK
BUSINE 2.9 QUESTIONS:

RISK Discuss in brief about financial risk.

(1)
BUSINESS RISK FINANCIAL RISK nature of financial risk.
BASIS FOR (2) Explain
of financial risk.
COMPARISON (3) Briefly discuss importance
The risk of Financial Risk is the (4) Discuss various methods to evaluate financial risk.
Meaning financial risk.
insufficient profit, risk arising due to t(5) Explain how to manage
Business Risk.
to meet out the use of debt financine (6) Explain
known |in the capital (7) Explain how to manage business risk.
expenses is
as Business Risk. structure. (8) Compare Financial and Business Risk.

Evaluation: Variability is EBIT Leverage Multiplier

and Debt to asset
ratio.

Connected Economic Use of debt capital

with: environment

Minimization: The risk cannot be If the firm does not

minimized. use debt funds, ther
will be no risk.

Types: Compliance risk, Credit risk, Market

operational risk, risk, Liquidity risk,
reputation risk, exchange rate risk,

financial risk, etc.

strategic risk etc.
Disclosed by: |Difference in net |Difference in the
operating income return of equity
and net cash flows.
shareholders.
 Vipul'sM Risk Managemer 33
(8 Evaluation of Risk
32
MODULE - II OF ORGANIZATION'S ABILITY TO
3.1 EVALUATION
BEAR RISK:

the business life cycle, companies face

In each stage of
Chapter3 both internal and external risks that can have detrimental

effects on operations. For startup businesses and

established organizations, the ability identify which risks
to

Evaluation of Risk pose a threat

to successful operations is a key component
of strategic business planning.

Business risks are identified using a n u m e r o u s methods,

Ability to Bear Risk but each identitying strategy relies on a complete analysis
3. Evaluation of Organization's
of specific business activities that could present challenges
Stakeholder Involved in
Business Risk
3.2
to the company Under most business models,
Risk Committee
3.3 Role of Risk Manager and preventable, strategic and external
organizations face
3.4 Questions threats that can be managed through acceptance, transfer,
reduction or elimination.

For proper evaluation of organization's ability to bear

risk following factors needs to be considered:
Risk appetite: Total exposed amount that an
organization wishes to undertake on the basis of risk-
return trade-offs for one or more desired and expected
outcomes.

Risk tolerance: Amount of uncertainty an organization

Is prepared to accept in total or more narrowly within a
certain business unit, a particular risk category, or for
a specific initiative.

Risk culture: Norms and traditions of behaviour of

individuals and of groups within an organization that
determine the way in which they identify, understand,
discuss and act on the risk(s) the organization
confronts and takes
 Vipul's'M Risk Managem

Evaluation of Risk 35
Desired level
of risk the
that the organiza
ore

Risk target:
objectives.
to meet its stakeholder of the startup. The return of the company's
believes is optimal
organiza on the success, or failure, of the
Amount of risk an
O Banization investment depends
Risk capacity: vested interested.
has
startup, meaning it
a
actually bear.
3.2.2 External Stakeholder:
or individuals
Risk attitude: Organization's Vle
perspective of the apparent qualitative and quantita External stakeholders are a little harder to identify, as

comparison to not have a direct relationship with the company.

value that may be gained in thee rela they do
relat external stakeholder is normally a person or
losses. Instead, an
potential loss or business.
organization affected by the operations of the
When a company goes
company over the allowable limit of carbon
RIS.wnea
3.2
3.2 STAKEHOLDER INVvOLVED IN BUSINESS emissions, for example, the town in which the company is
A stakeholder is a party that has an interest in located is considered an external stakeholder because it is
increased
company, and can either affect or
be affected byt affected by the pollution.
business. The primary stakeholders in a typical corporati
Conversely, external stakeholders may also sometimes
are its investors, employees and customers. However, have a direct effect on a company but are not directly tied
modern theory of the idea goes beyond this original noti to it. The government, for example, is an external
to include additional stakeholders such as a commun stakeholder. For e.g. when it makes policy changes on
trade association. carbon emissions, the decision affects the operations of any
government or

with increased levels of carbon.

Stakeholders can external. Intem business
be internal or

stakeholders are people whose interest in a company com Examples of a Company's Stakeholders: (Source:
through a direct relationship, such as through employmenwIkYpedia
ownership or investment. External stakeholders are thoStakeholders: Stakeholder's concerns
people who do not directly work with a company Du
affected in
Government taxation, VAT, legislation, employment,
some way by the actions and outcomes ot sa
truthful reporting, legalities, externalities
business. Suppliers, creditors and public groups a
considered external stakeholders. Employees rates of pay, job security, compensation,
respect, truthful communication.
3.2.1 Internal Stakeholder:
ethical
Investors are a common type of internal stakeholder a ustomers value, quality, customer care,

are
greatly affected by the outcome of a products.
Cxample, a venture
business Providers of products and services used in|
into a
capital firm decides to invest do Suppliers
technology startup in return for 10% ty the end product for the customer,
significant influence, the eq an inte equitable business opportunities.
firmn becomes a"
 Vipul'sTM Risk Management (BFM
Evaluation of Risk 37

new contracts, liquidity.

credit score,
and determine if there are conflicts of
Creditors participation,
Community jobs,
involvement, environmental interest among groups of stakeholders.

protection, shares, truthfu Assess influence: This stage involves measuring the
to which stakeholders can influence the project.
communication.
degree
condition, The more influential a stakeholder is, the more a
Trade Unions Quality of work worke
protection, jobs. project manager will need their support. Knowing what
each stakeholder needs or wants from the project will
profitability, durability, market share
enable the project manager to measure his or her level
Owner(s)
market standing, succession planning of support.
social goals.
raising capital, growth, Understand their expectations: This involves drilling
return on investment, income. down stakeholders' specific expectations. So it is
Investors
necessary to seek clarification when needed to be sure
3.2.3 Responding to Stakeholders Expectations:
they are completely understood.
than major stakeholder in th
Often there is more one
Define "success": Every stakeholder may have a
stakeholders addi
project. An increase in the number of different idea of what project success looks like.
stress to the project and influences the project's complexit Discovering this at the end of the project is a formula
business emotional investment of th for failure. Hence it is critical to
level The or
gather definitions up
stakeholder in the project and the ability of the stakeholde front and include them in the objectives to help ensure
to influence the project outcomes or execution approa that all stakeholders will be
supportive of the final
will also influence the complexity of the project. In additio outcomes.
to the number of stakeholders and their level of investmen Keep stakeholders involved: This stage requires requires
the degree to which the project stakeholders agree seeking inputs from different stakeholders. This can be
disagree influences the
project's complexity. done by measuring each stakeholder's capacity to
Some ler participate and honor time constraints.
commonly known
techniques to meet stakeno
expectations and managing stakeholder's risk are as 1o Keep stakeholders informed: It is critical to keep
Analyze stakeholders: Conduct a stakeho stakeholde
sending regular information and updates to all
analysis, or an assessment of a projects ke stakeholders. This requires
answering stakeholders'
participants, and how the project will affect t h e questions and emails promptly. Regular communication
is always appreciated and
problems and needs. Identify their
individue
may even protect the
characteristics and interests. Next
n company in case of bad
step is to i
to identi
any news or negative
what motivates them, as well as what provokes
then
developments.
Later it is
necessary to assign roles ana
level
 Vipul'sTM Risk Management (BM
3S Evaluation of Risk
39

stakeholders:
3.2.4 Risk and Unions a r e primarily concerned about
have different concerns and (6) Trade unions:
safety and security of its members. For this
Different s t a k e h o l d e r ' s For

risk: should periodically meet and discuss

management
Government: The main concern of government here :
issues related to workers and union. Further their
(1)
is fulfilng its tax liabili
to e n s u r e that the company t concerns should be addressed and resolved within

and is adherent to all laws and regulations. Thi specific time frame.
the company by havin
concern can be addressed by Ving (7) Owner and Investors: This category of stakeholders
adequate knowledge about
tax laws and a qualife looks to maximize their wealth. Corporates should
compliance team. always work with an intention of increasing their profits
stakeholders is concerned and ROI. Also adhering to regulatory requirements is
(2) Employees: This category of
about compensation, job security and truthfulness equally important along with profitability for long term
This concerned can be addressed by having proper HR growth of the company.
Also employees
policy with clear employee policies. need
to be updated about any major development in the
3.3 ROLE OF RISK MANAGER AND RISK
company. COMMITTEE:
(3) Customers: Customers expect quality service and 3.3.1 Risk manager (Chief Risk Ofmcer:
adequate customer care service. For this company
Risk management involves participationof everyone in
needs to have a separate customer service departnethe organization. However the most critical role is of Chief
and have proper quality policy. Risk Officer (CRO). It is
responsibility of CRO to collect
(4) Suppliers: Most important risk associated with necessary information from Risk team, financial controllers
suppliers is timely payment of goods or service and operations team. Also CRO is responsible for
provided by them. The company can address this ris organizing, developing and implementing the process of
by making timely payment (neither too early nor to 1dentitying, measuring and controlling credit risk, market
late) to all suppliers and creditors. In case of an risk, operational risk and liquidity risk in the
company.
delays in payment creditors needs to be intimated we Than periodically reports are prepared based on
in advance. information received by CR0 and presented to MD or CEO
of the
(5) Community: Society expects job company. These reports may be presented in board
creation, environme
policies.
protection and social welfare policies. Accordingmeetings and all critical
meetings critical aspects
aspects are discussed. Further
Accora
corporates should fulfill its cSR (Corporate eil based on feedback received from
the board necessary
Responsibilities) without any hesitation or expectauo corrective actions are initiated and deficiencies if any are
removed.
40
Vipul'sM Risk Management (BF Evaluation of Risk
41

on necessary deta
If required the CEO/MD may pass tail assume in its exposures
and business activities, given
loan bureau ior better del.
to credit team or distressed its businessobjectives and obligations to stakeholders.
are shared Wis
recovery. Also the details if required Committee have the resources and authority
operations and compliance team so that appropriate risk The
appropriate to discharge its responsibilities, including
be set which are in compliance with applicahi
process can
soleauthority to retain and terminate the engagement
regulations. consultants or independent counsel to the
of
ensure that all required helpful in
It is responsibility of CRO to Committee as it may deem necessary or
ed
to the board the establish the
actions are taken and suitably presented carrying out its responsibilities, and to
next time they meet. fees and other terms for the retention of consultants
and counsel, such fees to be borne by the Corporation.
3.3.2 Risk Committee:
The purpose of the risk management committee of the
Board of Directors (the "Board") of any company is to 3.4 QUESTIONS:
assist the Board in fulfiling its corporate governance (1) Write a note on "Evaluation of Organization's ability to bear Risk"
oversight responsibilities with
regard to the
(2) Discuss about Stakeholders involived in Business Risk.
identification, evaluation and mitigation of strategic
(3) Explain Role of Risk Manager and Risk Committee.
operational, and external environment risks. The
Committee has overall responsibility for monitoring and
approving the risk management framework and
associated practices of the Company.
The Risk Committee (the "Committee") is an
independent committee of the Board of Directors that
has, as its sole and exclusive function, responsibility tor
the risk management policies of the Corporation's
global operations and oversight of the operation of the
Corporation's global risk management framework.
The Committee assist the Board of
Directors in fulfiling
its oversight
responsibilities with regard to the
appetite of the
Corporation and the risk manageme
and compliance
framework and the governan governance

structure that supports it.

Risk appetite is defineda
the level and type
of risk a firm is able and willing to