25 - Risk Identification and Classification Flashcards
Risk identification defn.
Recognition of risks that can threaten an organisation’s business plan
Identifying all the risks in an organisation requires a good knowledge of:
- Recognise risks that will threaten the assets & income of the organisation by establishing context:
- > Business objectives
- > Company structures & finances
- > Who are the key stakeholders?
- > What is the area of business?
- > External environment
- Systematic or diversifiable?
- Preliminary identification of possible risk control processes
- Identify exploitable risks to gain competitive advantage
As well as:
- Input from people involved at all levels of the business
Techniques available to ensure all relevant risks have been identified:
- Risk classification to ensure all types of risk have been considered
- Risk checklists as used for regulatory purposes
- Experience of:
o Staff who have joined from similar organisations
o Consultants with broad experience of industry concerned - Project management risk identification methods:
o Preliminary risk analysis
o Brainstorming
o Desktop analysis
o Opinions of experts familiar w details of the project & plans for financing it
o Set out identified risks in a risk register/matrix
-> Cross reference risks where there is correlation
Project management:
Preliminary risk analysis
The initial high-level risk analysis done to confirm that the project does not have a high-risk profile st. it is not worth analysing further - in which case project should terminate
Project management:
Brainstorming
Brainstorming session held with project experts, senior internal & external people who are used to thinking strategically about the long term aimed at:
o Identifying project risks both likely/unlikely and their upsides/downsides o Discussing risk interdependencies o Attempting to place broad evaluation on risks considering both freq./severity of their occurrences o Generate initial mitigation options o Discuss the options briefly
Project management:
Desktop analysis
- Supplements brainstorming results by identifying further risks & mitigation options by researching:
o Further mitigation options
o Similar projects taken up by sponsor or others in the past (including overseas experiences)
What are the different risk categories?
- Credit risk
- Operational risk
- Market risk
- Business risk
- Liquidity risk
- External risk
What are the prerequisites to assessing the significance of each risk?
Why do we need to assess risk significance?
- Understanding of business undertaken by a provider
- Understanding of the organisational structure of the provider
Need to assess risk significance to:
- Determine how the outcome of the risk translates into financial impact on the balance sheet and cashflow requirements
Market risk defn:
Risks related to changes in investment market values or other features correlated with investment markets, such as interest and inflation rates
Market risk components:
- Consequences of changes on asset values (this is the most obvious implication)
- Consequence of investment market value changes on liabilities
- Consequences of a provider not matching asset and liability cashflows
Market risk:
Asset value changes
- Changes in the market values of equities and property
o May be systematic or specific
o Can be reduced by diversification across the mkt. and diff. systems - Changes in interest, inflation rates, currency rates or import tariffs
o Affect value of fixed-interest & index-linked securities
o Also has some effect on equities & property (domestic & overseas)
o Affect value of profits in home currency & prices of imports & exports
Describe the likely effect of an increase in short-term interest rates on the value of: o Fixed-interest bonds o Index-linked bonds o Equities o Property
FI Bonds:
> Increase in short-term int. rate => almost certain fall in short-term bond values
> Impact on long-term FI bonds unknown -> depend on investor views of future inflation & monetary policy
IL bonds:
- Increase in short-term int. rates is a sign of low future inflation => lower demand for IL bonds => lower price
Equities:
o Increase in short-term int. rates might depress economic growth => fall in equity values
Property:
-> Increase in short-term int. rates => lower valuation of future rents => lower value of property
Market risk:
Liability value changes
- These may arise if promises to stakeholders are directly linked to investment market values or interest rates eg. unit-linked or inflation-linked benefits
- Change in interest rates or inflation may affect the amount of capital a provider needs to establish for future liabilities
o Changes the basis used to value liabilities
Market risk:
Why do we need asset-liability matching?
- Market risk can be significantly reduced if the assets matched the liabilities in terms of currency , nature and term.
Market risk:
Why may perfect asset-liability matching be impossible in practice?
- Variety of assets may be insufficient (particularly long-term assets for retirement benefits)
- Cost of maintaining fully-matched portfolio may be prohibitive
- Liabilities may:
o Include discretionary benefits
o Be uncertain in amount and timing
o Include options and hence have uncertain CFs after the option date
