1. Introduction to Risk Management Flashcards
(38 cards)
Compare the terms possibility and probability.
1.1
Possibility does not indicate the likelihood of an event occurring, probability does.
Probability is measurable and has a value between 0 and 1.
p(x) = 0 is impossible
p(x) = 1 is certain
0 < p(x) < 1 is possible
What two elements make up risk?
1.1
- Uncertainty of outcome.
2. Possibility of a negative outcome.
What is the difference between uncertainty and possibility?
1.1
Risk involves uncertainty about the type or timing of outcome (or both.) These result in the inability to accurately predict the future.
Possibility means that an outcome or event may or may not occur. Because of the possibility of a negative outcome, risk exists.
How does classifying the various types of risk help in the risk management process?
1.2
Classification can help with
- Assessing risk - Controlling risk - Financing risk
List the four broad classifications of risk outlined in the text.
1.2
- Pure vs. speculative risk.
- Subjective vs. objective risk.
- Diversifiable vs. nondiversifiable risk.
- Quadrants of risk.
Compare pure and speculative risk.
Which type of risk does insurance primarily deal with?
1.2
Pure risk - chance of loss or no loss; no chance of gain, e.g. fire risk.
Speculative risk - chance of loss, no loss, or gain, e.g. stock purchase.
Insurance deals primarily with pure risk.
Describe two types of speculative risk.
1.2
Examples of speculative risk
- Financial investments
- Business activities
a. Price risk.
b. Credit risk.
Compare subjective and objective risks.
1.2
Subjective risk - perceived amount of risk - based on opinion Objective risk - measurable variation in outcomes - based on facts and data
Why is it important to align subjective risk with objective risk?
1.2
The closer an organization’s subjective interpretation of risk is to the objective risk, the more effective its risk management plans are likely to be.
What are the reasons that subjective risk can differ substantially from objective risk?
1.2
- Familiarity and control
2. Severity over frequency
Describe the difference between diversifiable and nondiversifiable risk.
1.2
Diversifiable risk
- affects a small portion of the population.
- e.g., fire destroying a factory
Nondiversifiable risk
- affects a large portion of the population.
- e.g., inflation increases building costs
What types of risk do private insurance and government insurance address?
1.2
Private insurance tends to concentrate on diversifiable risks.
Government insurance is often suitable for nondiversifiable risks.
No clear line of demarcation exists.
Name the “quadrants of risk” described in the text and used in enterprise risk management.
1.2
- Hazard risks
- Operational risks
- Financial risks
- Strategic risks
Describe hazard risks.
1.2
Hazard risks are traditionally managed by risk management professionals.
Describe operational risks.
1.2
Operational risks
- pure risks
- fall outside of Hazard Risk category
- could jeopardize:
- service-related business functions.
- manufacturing-related business functions.
Describe financial risks.
1.2
Financial risks directly affect an organization’s financial position via changes in
a. revenue, b. expenses, c. business valuation, d. the cost of capital, or e. the availability of capital.
Describe strategic risks.
1.2
Strategic risks
- are fundamental to an organization’s
existence and business plan
- have a current or future effect on earnings
or capital, due to
- adverse business decisions
- improper implementation of decisions
- lack of responsiveness to market
changes
What are the three financial consequences of risk?
1.3
- Expected cost of losses or gains
- Expenditures on risk management.
- Cost of residual uncertainty
Describe what is included in the calculation of the expected cost of losses or gains.
1.3
Total cost of losses
= Direct costs + Indirect costs
The overall effect of losses is much greater than the cost of direct losses themselves
Describe the difference in calculating the expected cost of losses or gains for speculative risks vs. pure risks.
1.3
Speculative risk
=> wider range of outcomes
=> calculation is more complex
Pure risk
=> narrower range of outcomes
=> calculation is simpler
Describe expenditures on risk management in the context of financial consequences of risk.
1.3
Include
- cost of risk financing techniques
- e.g., insurance
- risk control techniques
- e.g., safety measures
What is the cost of residual uncertainty?
1.3
The level of risk that remains after implementation of risk management plans.
- difficult to measure
- may have significant financial impact
- e.g., risk of expanding business
=> increase operational costs later
=> delay construction on new factory
To minimize the adverse effects of lost or missed opportunities, what risk management efforts are undertaken?
1.4
Efforts to efficiently and effectively
a. assess risk. b. control risk. c. finance risk.
What three elements does every loss exposure have?
1.5
Asset exposed to loss
Cause of loss (peril)
Financial consequences of loss