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F106 Enterprise Risk Management '24 > 3. Risk taxonomy > Flashcards

3. Risk taxonomy Flashcards

1
Q

Risk concepts

A

Exposure
Volatility
Probability
Severity
Time horizon
Correlation
Capital

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2
Q

Exposure

A

Maximum loss that can be suffered from event

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3
Q

Volatility

A

Broadly measures variability within range of possible outcomes

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4
Q

Probability

A

Likelihood of an event

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5
Q

Severity

A

Loss likely to be expected from an event

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6
Q

Time horizon

A

Length of time exposed to risk OR time required to recover from / reverse effects of event

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7
Q

Correlation

A

Degree to which different risks behave similarly in response to common events

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8
Q

Capital

A

Risk- money set aside to cover unexpected losses
Working- money ser aside to support business strategy

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9
Q

What is risk taxonomy?

A

Full list, description and categorisating of risks faced by organisation

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10
Q

What are the 5 high level risk categories?

A

Market
Credit
Liquidity
Operational
Underwriting/insurance

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11
Q

Give a more detailed risk list

A
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12
Q

Define market risk

A
  • Risks arising from changes in investment market values or other correlated features e.g. interest rates and inflation
  • Incl. consequences of changes in asset values on liability values and asset liability matching
  • May refer to risk of changes in the market conditions e.g. lower sales / profit margins
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13
Q

What are the components of market risk

A

Trading risk
A/L mimatching
Liquidity risk
Repatriation risk

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14
Q

Economic risk definition

A

Risk arising from impact of macroeconomic factors on an org and/or customers

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15
Q

Examples of economic risk

A

o Aggegrate supply and demand
o Own and foreign govt policies
o (Un)employment levels
o Inflation, interest and FX rates
o Accommocation costs incl house prices

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16
Q

Interest rate risk definition

A
  • Arise from changes in interest rates incl.
    o Impact on consumer behaviour
    o Financial impact
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17
Q

FX risk definition

A
  • Arises from exposure to movement in FX rates
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18
Q

What do changes in FX affect?

A

o Transaction exposure- foreign revenues and costs as expressed in home currency
o Economic exposure- prices of exported goods&raquo_space; impact on foreign sales
o Translation exposure- consolidated accounts (think how FX affects results in segment reporting)

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19
Q

Basis risk definition

A
  • Arises from differences in the movements of two comparable indices
20
Q

Credit and counterparty risk

A
  • Credit- risk counterparty to agreement is unable or unwilling to make payments required under agreement.
  • Counterparty – Risk another party to transaction or agreements fails to perform contractual obligations, incl. performing them on time.
21
Q

What else might credit risk refer to?

A
  • May refer to risks relating to variations in credit spreads in the market
    o Caused by changes in asset values e.g. for a corp bond, due to actual or perceived change in creditworthiness of issuer
    o Sweeting considers it a market risk
    o Changes in creditworthiness may be informed by assessment of risk of not meeting contractual obligations (in terms of quantity, quality or timing) in part/in full due do inability/decision of issue
22
Q

Liquidity risk definition

A
  • Funding- risk money markets can’t supply funding to organisations when needed
  • Market - risk of insufficient market capacity to handle asset transactions at time when deal is required without sizeable change in price
23
Q

Insurance risk definition

A

Risk from deviations in timing, frequency and severity of insured events, relative to expectations that were held when underwriting or pricing

24
Q

Underwriting risk definition

A

risk of inappropriate selection and approval of insurance risk (component of insurance risk)

25
What are some components of insurance risk?
Mortality Morbidity Property Persistency Expenses Casualty risks Underwriting risk
26
Operational risk definition
Risk of losses due to inadequate / failed internal processes, people, systems or form external events.
27
Components of operational risk
* Processes * People * Systems * Events * Strategic risk * Crime risk
28
Examples of risks in processes
 Efficiency vs effectiveness  Errors  Inadequate documentation  Model and data risks
29
Examples of risks caused by people
 Key positions unfilled  Wrong people employed / promoted / retained  Absenteeism  Lack risk awareness  Incompetence  Dishonesty  Agency risks  Moral hazard risks  Adverse selection
30
Examples of system risks
 Out-of-date  Insufficient access or capacity  Unauthorised use / access to data  Technological failure  Inadequate back up systems / disaster plans  Software errors
31
Examples of risks brought about by events
 Business continuity  Ineffective internal-change management  Ineffective external-change management
32
Example of strategic risks
 Inappropriate business strategy  Inadequate business plans  Changes in external environment  Results not meeting s/h expectations  Reputational risk
33
Examples of crime risks
 People risk  Technological / cyber risk  Legal risk
34
Environmental risk definition
* Relates to natural environment and human interactions with the environment * Includes: o Natural disasters and climate change o Pollution o Impact of declining natural resources
35
Legal risk definition
* Arises from understanding of and adherence to legislation, incl. changes in accepted interpretation
36
Causes of legal risk
o Breaching law e.g. -Lack of awareness -Lack of understanding -Interpretation changes by law -Deliberately o Inability to demonstrate compliance with law
37
What are 3 things that legal risks relate to?
o New legislation due to political or social pressures: o Clauses, terms, or conditions in contracts o Court judgements against org
38
Political risk definition
* Includes: o Risks related to political decisions and indecision o Changes in govt o Events related to political instability incl. terrorism and war
39
Conduct risk definition
* Risks relating to relationship between company and customers
40
Examples of things that might affect conduct risk
o Operational failures- poor quality control and/or servicing o Information asymmetry o Keeping up with regulation and customer needs o Market conditions o Product development activities o Strategic objectives
41
Other risks
* Regulatory * Agency * Reputational * Project * Strategic * Demographic (e.g. mortality rates) * Moral hazard * Social (e.g. population characteristics, e.g. age profile) * Pension * Residual risk
42
Examples of systematic risk
o Market return o Industry-specific risks (limited number of sectors so can’t diversify fully) o Interest rates for pension liabilities
43
Examples of non-systemic risk
o Non-systematic individual company return o Components of insurance risk
44
Concentration of risk definition
Risk of relying on success of one action without back up plan if fails
45
Causes of concentration risk
o Inability to diversify and reduce risk o Deliberate decision e.g. high expected returns in product/asset o Poor risk management
46
Contagion risk definition
* Might be called “systemic risk” * When financial losses in a company or sector or country leads to losses in another * Exacerbated by media and way in which info is presented and spread
47
Examples of contagion risk
o Financial infrastructure- Failure of commonly used system e.g. visa o Funding liquidity risk- e.g. 2008 credit crunch o Common market positions- where change in one share price leads to further changes o Exposure to common counterparty- failure in one leads to failure in one // loss of confidence in sector o Credit contagion- default of one org leads to financial difficulties for creditors and suppliers >> more defaults etc o Investors using the same flawed logic

F106 Enterprise Risk Management '24 (35 decks)

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