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Introduction and Risk MGT 3

This document discusses the fundamentals of risk management. It outlines various types of risks businesses face, such as competitor risk, country risk, criminal risk, economic risk, and more. It emphasizes the importance of understanding the risks a business is exposed to, grading risks, and developing a risk management policy to address unacceptable risks. The costs of risks to businesses are also examined, including risk identification costs, risk handling costs, actual losses, and more. Overall, the document provides a broad overview of risk management principles and the risks that businesses should seek to understand and mitigate.

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Mridul Seth
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53 views

Introduction and Risk MGT 3

This document discusses the fundamentals of risk management. It outlines various types of risks businesses face, such as competitor risk, country risk, criminal risk, economic risk, and more. It emphasizes the importance of understanding the risks a business is exposed to, grading risks, and developing a risk management policy to address unacceptable risks. The costs of risks to businesses are also examined, including risk identification costs, risk handling costs, actual losses, and more. Overall, the document provides a broad overview of risk management principles and the risks that businesses should seek to understand and mitigate.

Uploaded by

Mridul Seth
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Introduction of Financial

Engineering and Risk Mgt.


Chapter-1
The fundamentals of risk
management
 To be in business you must make
decisions, each of which involves
risk. Taking a particular gamble may
have turned out to be the best thing
you ever did.
 Repeatedly “Bet the business” is

asking for trouble.


 The unpleasant surprises can be kept

to a minimum.
One should know the secret
 The risks to which you are exposed.
 If they are big enough to worry about
 If there is anything you can do to protect
against them.
 What it will cost to reduce or to hedge
your risks.
 Then, if action is needed, do something
about it. Ask yourself the following
questions.
 Are the risks to your business clearly understood
– particularly if you have a portfolio of different
activities?
 Do you grade the risks faced by your business in a
structured way?
 Do you know the maximum potential liability of
each exposure?
 Are the risks large in relation to the turnover of
your business? What impact could they have on
your profits and balance sheet?
 Over what time periods do the risks exist? Are
they one-offs or recurring?
 Is there an effective risk management policy with
responsibility at board or senior executive level?
Do you differentiate between hedging your risks
and speculating for profit?
Principal business risks
 Competitors
 Country
 Criminal/fraud
 Economic
 Environmental
 Financial: conunterparty, funding, currency,
interest rate.
 Information
 Legal ; market; operational ;personal political;
product/industry; public relations; Resources;
technological; War/terrorism.
Competitor Risk
 The harsh realities of competition are well-
known and understood by anyone in
business- from the pricing and marketing
of products or services to the speed at
which others copy your new ideas.
 Who will you be competing with
tomorrow?
 Do you know where your competition is
going to come from?
Country risk
 Political risk: including exchange controls and
other restrictions on the remittance of profits,
capital or other payments.
 Social and economic stability.
 Trading practices, customs and ethics.
 Restrictions on foreign ownership and
management.
 Delays in money transmission.
 There should be a predetermined limit to the
amount of exposure you will accept relating to
any single country. These limits should be
reviewed regularly, and immediately in the light
of changing events.
Criminal risk (including fraud)
 Theft, criminal damage, computer “hacking and
arson are all risks to which businesses are
accustomed or can relate, and for which insurance
may be available, but consider in addition the
following:
 Fraud, including the actions of employees under
pressure to produce results.
 When an employee resigns or is dismissed, what do
they take with them to help in their next job? This
has been made very much simpler by the advent of
computers, where so much information can be
stored on a disk that drops into a pocket. Do you
have password protection at different levels?
 Industrial espionage is a major problem in
some sectors, whether through corrupt
employees or sophisticated electronic
“snooping” devices. Business susceptible
to this risk are usually well aware of the
dangers and take appropriate action.
 In some territories corruption and criminal
control of business are endemic. If you
decide to operat in such countries, take
advice from those who know the area,
and be prepared to get on the next plane
home if things turn unpleasant.
Economic risk
 Economies are inherently cyclical, with
potentially wide fluctuations inactivity
levels and asset values. However long
predicted, the transition from a bull to a
bear market usually happens with a speed
that catches people out and leaves them
to count their losses.
 The cycle is such a powerful combination
of upside greed and downside fear that to
some extent it will always be with us.
Environmental risk
 The need to comply with environmental or
safety legislation, the costs of which can
be considerable – it may not even be
economically viable to continue your
operations.
 Higher costs, or shortages, of raw
materials if your suppliers are hit by these
problems.
 Damage to the public image of your
business if targeted as environmentally
unsound by pressure groups
 Diminution in the value of an asset when
pollution is found.
Information risk
 Your business will only be as good as
the information on which decisions
are based , including:
 Costs- at each stage of every

process
 Liabilities-actual and contingent

 Risks-exposures, maximum potential

liabilities and available protection;


resources; techonology
Legal risk
 Documentation risk: documentation risk
results from errors or omissions in
documents. These can arise from
misunderstanding or ignorance as to the
meaning or significance of terms and
expressions, or not taking the time and
trouble to check a document thoroughly
before signing.
 Are all staff aware of the risks to which
they may be exposing the business by
seemingly innocent statements or acts?
Security risk
 If you take security in support of a lending
or other transaction make sure:
 It can be enforced against the appropriate
party in the relevant jurisdiction without
incurring disproportionate costs or
liabilities.
 Where it is necessary for the security to be
‘registered’, that this is done within the
time period allowed for that purpose.
 The security documents themselves are
put in a safe place with copies available
for ease of reference.
Litigation
 The costs of litigation, both financial
and in time, can be so great that
even the most frivolous claim may
seriously damage your business.
 Belief that, “whatever goes wrong,

someone else must pay. This


compensation culture approach,
whatever its justification or causes, is
becoming a major problem for many
businesses.
Market risk
 In its simplest form this is the exposure to an
adverse change in the price or value of something
in which you trade or are holding as an
investment.
 Inventory risk is a variant of market risk an
example of which would be exposure to a fall in
the value of securities held by a bank or other
financial institution for trading purposes.
 Liquidity risk arises when a market does not have
the capacity to handle the volume of whatever
you are trying to buy or sell at the time you want
to deal.
Personnel risk
 Many industries are service industrioes
which depend mostly on the quality of
their staff for success.
 By and large, every company needs
personnel to operate. The loss of an
important/key empolyee due to
resignation/deth/sickness could be a
mojor risk to the performance of the Co.
 CO. could also incur heavy losses due to
frauds committed by its staff.
Meaning of Risk
 1. Pure Risks and Speculative Risks: these are those
in which the outcome tends to be a loss with no
possibility of gain, while speculative risks are those
in which there is a possibility of profit or loss.
 2. Acceptable Risks and Non-Acceptable Risks: while
risks are unavoidable in any business, the potential
loss may be so minimal that some risks are
acceptable without any prevention being taken are
known as non-acceptable risks. For unacceptable
risks, the mgt. must find out ways to reduce, avoid
or transfer the risk for example, a loss of 10 ball
point pens in a month is an acceptable risk to the
business, but a major financial loss of Rs20 cr. Is a
non-acceptable risk.
 3. Static Risks and Dynamic Risks:
there are various risks that depend on
changes in the economical, political,
social and other scenarios. Such risks
are known as dynamic risks.
Speculative are types of dynamic
risks.
 Risks that do not depend on various

scenarios, are known as static risks.


Pure risks are types of static risk.
Cost of Risk
 There are various costs involved in risk.
These can be segregated a risk identifying
cost, risk handling costs, actual losses,
social costs, loss financial costs, loss
control costs and cost of residual
uncertainty.
 Risk Handling cost: after risk identified
certain expenses of handling them are to
be incurred like insurance premiums,
alarm installation and loss prevention
devices etc.
 Actual Losses: Actual loses imply direct as
well as indirect losses. Damages caused by
fire, death of personnel, injuries, loss of
production and finished stocks are direct
losses while indirect losses imply
productivity reduction, stoppages etc. which
will happen if the fire takes place.
 Social Costs: Co. may have to undertake to
compensate the society for whatever
damages may be caused by its action or by
pure risks. i.e. Union carbide.
 Residual Uncertainty Cost: residual
uncertainty about certain risk may make
the staff uncomfortable about the future
and they may demand higher wages to
continue with the co.

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