Ch. 1: Intro to RM Flashcards
traditional concept of risk (definition)
Risk is a hazard that could happen to an individual or organization.
evolved concept of risk (definition)
Risk is uncertainty about outcomes that can be either negative or positive.
ISO acronym
International Organization for Standardization
book’s definition of risk management
The process of making and implementing decisions that enable an organization to optimize its level of risk.
the four high-level categories of risk
Hazard (pure) risks
Operational risks
Financial risks
Strategic risks
hazard risk (definition)
Risk from accidental loss, including the possibility of loss or no loss
risk profile (definition)
A set of characteristics common to all risks in a portfolio
Why has risk management evolved?
In part because of high-profile failures of large organizations during the late twentieth and early twenty-first centuries, followed by the global financial crisis.
systemic risk (definition)
The potential for a major disruption in the function of an entire market or financial system.
cost of risk (definition)
The total cost incurred by an organization because of the possibility of accidental loss.
An organization’s cost of risk is the total of these factors
costs of accidental losses not reimbursed by insurance or other sources +
insurance premiums & expenses for non-insurance indemnity +
costs of risk control techniques to prevent or reduce the size of accidental losses +
costs of administering risk management activities
how risk management reduces the deterrent effects of uncertainty
by making losses less frequent, less severe, or more foreseeable
how reducing uncertainty benefits an organization
alleviates/reduces management fears about potential loss, increasing feasibility of risky ventures
increases profit potential by greater participation in investment/production activities
makes operation safer investment, more attractive to investors
risk appetite (definition)
the total exposed amount that an organization wishes to undertake on the basis of risk-return trade-offs for one or more desired and expected outcomes
how risk management benefits the economy as a whole
reduces waste of resources, improves allocation of productive resources, and reduces systemic risk
examples of typical risk management goals (8)
tolerable uncertainty legal & regulatory compliance survival business continuity earnings stability profitability & growth social responsibility economy of risk management operations
value at risk (definition)
A threshold value such that the probability of loss on the portfolio over the given time horizon exceeds this value, assuming normal markets and no trading in the portfolio
examples of typical bases for legal obligations (3)
standard of care owed to others
contracts entered into by the organization
federal, state, provincial, territorial, and local laws & regulations
an organization’s survival depends on…
identifying as many risks as possible that could threaten the organization’s ability to survive and managing those risks appropriately, and on anticipating and recognizing emerging risks
four steps to provide business continuity & resiliency
identify activities whose interruptions cannot be tolerated
identify the types of accidents that could interrupt such activities
determine the standby resources that must be immediately available to counter the effects of those accidents
ensure the availability of the standby resources at even the most unlikely and difficult times
the basic measures that apply to risk management (6)
exposure volatility likelihood consequences time horizon correlation
exposure (definition)
Any condition that presents a possibility of gain or loss, whether or not an actual loss occurs
volatility (definition)
Frequent fluctuations, such as in the price of an asset
law of large numbers (definition)
A mathematical principle stating that as the number of similar but independent exposure units increases, the relative accuracy of predictions about future outcomes (losses) also increases
time horizon (definition)
estimated duration
consequences (definition)
The measure of the degree to which an occurrence could positively or negatively affect an organization
correlation (definition)
A relationship between two variables
4 of the most commonly-used risk classifications
pure/speculative risk
subjective/objective risk
diversifiable/nondiversifiable risk
quadrants of risk (hazard/operational/financial/strategic)
pure risk (definition)
A chance of loss or no loss, but no chance of gain
speculative risk (definition)
A chance of loss, no loss, or gain
credit risk (definition)
The risk that customers or other creditors will fail to make promised payments as they come due
categories of speculative risks in investments (4)
market risk
inflation risk
interest rate risk
liquidity risk
market risk (definition)
The risk associated with fluctuations in price of financial securities, such as stocks and bonds
inflation risk (definition)
The risk associated with the loss of purchasing power because of an overall increase in the economy’s price level
interest rate risk (definition)
The risk associated with a security’s future value because of changes in the interest rates
liquidity risk (definition)
The risk associated with being able to liquidate an investment easily and at a reasonable price; the risk that an asset cannot be sold on short notice without incurring a loss
subjective risk (definition)
The perceived amount of risk based on an individual’s or organization’s opinion
objective risk (definition)
The measurable variation in uncertain outcomes based on facts and data
3 reasons subjective risk and objective risk may differ
familiarity & control (flying perceived riskier than driving)
consequences over likelihood (“it can’t happen to me”; “I’m jinxed”)
risk awareness
diversifiable risk (definition)
A risk that affects only some individuals, businesses, or small groups
nondiversifiable risk (definition)
A risk that affects a large segment of society at the same time
market risk (definition)
Uncertainty about an investment’s future value because of potential changes in the market for that type of investment
hazard risk arises from
arises from property, liability, or personnel loss exposures
operational risk arises from
arises from people, processes, systems, or controls
financial risk arises from
arises from the effect of market forces on financial assets or liabilities
strategic risk arises from
arises from trends in the economy & society
3 main theoretical concepts of ERM
interdependency
correlation
portfolio theory
common impediments to successfully adopting ERM (2)
technological deficiency (insufficient data/communication) traditional organizational culture with entrenched silos
