Ch26: Risk identification and classification

Question 1

Steps for identification and analysis of risks facing a project (5)

Answer 1

• High level preliminary risk analysis to confirm that the project does not have such a high-risk
  profile that is is not worth analyzing further, in which case, project should not proceed.
• Brainstorming session of project experts and senior internal and external people who are
  strategic thinkers. (Aim will be to: identify, discuss interdependency, initial evaluation, initial
  mitigations)
• Desktop analysis to supplement results of brainstorming session; identifying further risks and
  mitigation options (research similar projects)
• Obtain considered opinions of experts familiar with details of project and outline plans for
  financing it
• Set out all identified risks in a risk register or risk matrix, with cross-references to other risks
  where there is inter-dependency

Question 2

Main risk categories (7)

Answer 2

• Market risk
• Credit risk
• Liquidity risk
• Business risk
• Operational risk
• External risk
• Climate risk

Question 3

Market risk definition and subcategories

Answer 3

Risks related to changes in investment market values or other features correlated with investment markets, such as interest and inflation rates.

• changes on asset values
  + changes in equity and property MV’s
  + changes in interest and inflation rates
• changes of market values of liabilities
  + inflation rates effect amounts; interest rates effect valuations
• mismatching asset and liability cashflows
  + consequences include higher exposure to market risk, higher liquidity risk, reinvestment
  risk
• Currency risk: When liabilities are denominated in a certain currency and assets in another,
  company is exposed to adverse changes in the exchange rate.

Question 4

Liquidity vs marketability

Answer 4

Liquidity: How quickly can you convert an asset into cash at a predictable price, i.e. without significant loss of principal

Marketability: How easy it is to sell an asset

Question 5

Business risk definition and subcategories (5)

Answer 5

Risks that are specific to the business undertaken and are financial in nature.

• Underwriting risk (arising in relation to the underwriting approach taken)
• Insurance risk (arising from uncertainties relating to claim rates and amounts)
• Financing risk (arising in relation to the financing of projects or other activities)
• Exposure risk (arising in relation to amount of business sold, concentration, diversification)
• Competition risk (arising in relation to competitor prices and actions in the market)

Question 6

Operational risk definition and subcategories

Answer 6

Refers to the risk of a loss resulting from inadequate or failed internal processes, people and systems. Non-financial events with financial consequences.

• Arise from inadequate or failed internal processes, people or systems
• Conduct risk (company’s actions result in poor outcomes)
• Dominance risk (risk of individual dominating business)
• Key person risk (risk that business cannot be sustained without a key person)
• Third-party risk
• Failure of plans to recover from an external event

Question 7

Climate risk definition and subcategories

Answer 7

Risks arising from adverse changes in the physical environment and secondary impacts on the economy at a regional or global level.

• Physical (first-order effects of environmental changes such as greenhouse emissions, pollution
  and land use.
• Transition (Refers to economic, political and market changes as a result to mitigate climate
  change. E.g. changes in consumer preferences towards greener products, changes in
  government policy towards fossil fuel consumption.
• Liability (Parties seeking compensation for the impacts of climate change; mostly general
  insurance products such as professional indemnity and public liability)