5.2 Defining risk

Question 1

Define risk.

Answer 1

Any situation where an action or decision could result in more than one potential outcome.

Question 2

What is the difference between risk and uncertainty?

Answer 2

Uncertainty is not quantifiable, whereas risk is.

Question 3

What is the “Knightian uncertainty concept”?

Answer 3

The concept developed by Frank Knight that uncertainty is not quantifiable due to unpredictability, but that risk can be estimated using statistical methods.

Question 4

The degree of uncertainty in a decision with often depend on:

• the chosen risk model and underlying a__________
• availability and quality of d___
• the chosen model p_________ such as time horizon or frequency of data inputs
• the chosen c__________ level

Answer 4

assumptions
data
parameters
confidence

Question 5

A common factor in uncertainty is the human element. What do we mean by this?

Answer 5

Human behaviour is very unpredictable, making it hard to determine how people will react to specific decisions or outcomes.

Question 6

What is a “confidence interval” in determining uncertainty in a particular risk?

Answer 6

A percentage value referring to the extent to which we are confident in the accuracy of any statistical estimate.

Question 7

What is meant by a “risk event”?

Answer 7

The outcome that arises from a single decision or action that could result in more than one outcome.

Question 8

What is meant by a “loss event”?

Answer 8

A risk event with a negative outcome (e.g. injury, financial loss).

Question 9

What is meant by probability in terms of risk?

Answer 9

The likelihood that a give outcome will occur.

Question 10

What is meant by impact in terms of risk?

Answer 10

The scale of a particular positive or negative outcome. e.g. minor, severe, critical, fundamental etc.

Question 11

What is meant by exposure in terms of risk?

Answer 11

Exposure is a measure of probably future outcome resulting from a single decision or action.

Question 12

What is meant by time horizon?

Answer 12

The time period over which risk is analysed.

Question 13

How is risk exposure calculated in its simplest form?

Answer 13

Exposure = probability x impact

Question 14

What is the difference between a “pure” risk and a “speculative” risk?

Answer 14

Pure risks are risks with only a negative or neutral outcome, while speculative risks also have a positive element.

Question 15

What is the difference between “inherent” and “residual” risk?

Answer 15

Inherent risk is the level of risk exposure before controls are applied, while residual risk is the level of risk exposure with controls in place.

Question 16

What is meant by a “principal risk”?

Answer 16

A significant or key risk, considered material and which can affect the viability of the business.

Question 17

What is an emerging, or disruptive, risk?

Answer 17

A risk that does not yet affect an organisation but may develop to become a principal risk in future.

Question 18

What is meant by “risk profile”?

Answer 18

A combination of all principal risks that an organisation faces.

Question 19

What is “tail” risk?

Answer 19

Unknown unknowns, or black swan events, arising from highly improbable and difficult to predoct events.

Question 20

Give an example of a recent black swan event.

Answer 20

Coronavirus pandemic
Lehman Brothers collapse
9/11 attacks

Question 21

What is meant by “cliff risk”?

Answer 21

The risk arising from an event that is probable and has widespread ramifications (e.g. leaving the EU without a deal).

Question 22

What is “wrong way risk”?

Answer 22

The risk when risk exposure to a counterparty is adversely correlated to the credit quality of that counterparty.

Question 23

What is “risk taxonomy”?

Answer 23

A set of all the risk categories used within a given organization.