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Risk In Financial Services > Chapter 1: Principles of Risk Management (14 marks) > Flashcards

Chapter 1: Principles of Risk Management (14 marks) Flashcards

1
Q

What’s the difference between risk and uncertainty?

A

Variability that can be quantified is risk, but if it can’t it’s uncertainty.

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2
Q

What do we need to quantify variability?

A

large amounts of repeating data.

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3
Q

Which risk is easy to quantify?

A

Market and credit risk as there’s lots of data available.

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4
Q

Which risk is hard to quantify?

A

Strategic and operational risk and events are unique.

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5
Q

What does risk management focus on?

A

Identifying what could go wrong, which risks should be dealt with and implementing strategies to address risk.

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6
Q

Where do external risks arise from?

A

Unforeseen changes in:
* Global economy
* Political arena
* Competitive environment
* Social and market forces
* Environmental
* Technological and cyber security.

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7
Q

What’s economic risk?

A

Changing patterns in human behaviour which leads to misallocation of resources in production.

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8
Q

What’s political risk?

A

Change in government, their economic policies/tax law affecting market performance.

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9
Q

What are 3 ways in which political changes affect financial services firms?

A
  • Rise or fall in markets in which firms invest.
  • Changes in demand for the products which an industry sells.
  • Changes in legislative and regulatory environment in which financial services firms operate.
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10
Q

Changes in competitive environment risk?

A

Firms are affected by the performance of competitors. I.e. if a competitor gains more market share, the it may be too expensive for the incumbent firm to continue thus exit the market.

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11
Q

What are risks from social and market forces?

A

Changes in:
* Tech changes and their impacts on products and their use
* Changes in consumer behaviour
* Rising inequality of wealth distribution
* Propensity to save
* Attitudes to living on credit
* House prices and their relationship to demographic changes.

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12
Q

What’s technological risk?

A

Firms don’t anticipate technological change and run the risk of becoming obsolete.

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13
Q

What’s cyber risk?

A

Theft or damage of information stored on computers, as well as websites and systems that run on those computers.

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14
Q

What risks do Shocks or natural disasters pose?

A

Adverse affects to national or global economy.

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15
Q

Which external stakeholders can present external risk?

A
  • Parent company
  • Significant holdings by institutional investors
  • Large customers
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16
Q

What external risks are caused by a parent company?

A

When the parent company wants to alter the plans of their subsidiary firm, they must be careful in how it formulates these plans as it can cause great inconvenience to the subsidiary firm.

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17
Q

What external risk can be caused by institutional investors with significant holdings in a company?

A

Investors gain influence through voting rights if they hold a certain percentage of shares. Despite having contrasting views with board members, there could be little done to stop them pushing for change.

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18
Q

What risks are posed by having one large customer?

A

Relationship must be carefully managed, especially if other firms can provide a similar service to this customer - don’t want to lose them if you’re over-reliant on their business.

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19
Q

What is the key to managing stakeholder risk?

A
  • Build relationships at senior levels.
  • Understand their agenda and how it may differ from the firm’s own agenda.
  • Manage expectations with any new developments.
20
Q

Which third parties can be a source of external risk?

A
  • Regulators
  • Brokers
  • Solicitors
  • IT and data suppliers
  • Outsourced back-office administrators
  • Advisory/industry consultants
21
Q

What must firms do to reduce third party risk?

A

Ensure they can source products form alternative suppliers, so if third party defaults on delivery there’ll be no disruption of service.

22
Q

What are ESG risks?

A
  • Environmental risks
  • Social risks
  • Governance risk
23
Q

Where do environmental risks emanate from?

A
  • Climate change issues (firms vulnerability to it)
  • Issues around depletion of natural resources, e.g. water scarcity, land use, raw-material sourcing.
24
Q

Where do Social risks emanate from?

A
  • Human capital issues (labour management and health and safety).
  • Product liability issues (product safety, quality, privacy).
  • Stakeholder opposition (local health and demographic risks, controversial sourcing of materials).
25
Q

Where do governance risks emanate from?

A
  • Corporate governance issues (management structure and board-employee relations and compensation).
  • Corporate behaviour issues (business ethics and anti-competitive practices, etc.)
26
Q

What can ESG risks manifest themselves as?

A
  • Negative impacts on business objectives - loss of rev and reputation damage.
  • Direct financial costs - losses from non-environmentally friendly products.
  • Secondary impacts - losses form lawsuits associated with products.
27
Q

What is the COSO Framework?

A

Committee of Sponsoring Organisation of the Treadway Commission.

28
Q

What does the COSO framework argue?

A

ESG issues are central to a company’s risk and decision making and need to be integrated into an enterprise-wide risk management system.

29
Q

What 3 techniques are used to help understand a firm’s external risk profile?

A
  • PESTLE analysis
  • Business continuity planning
  • Business process analysis
30
Q

What is PESTLE?

A

Analysis of macro environment in which a business operates.

31
Q

Why is PESTLE useful?

A

Contains factors which are beyond a firm’s control which are important to be aware of.

32
Q

What headings does PESTLE include?

A
  • Political
  • Economic
  • Social
  • Technological
  • Legal
  • Environmental
33
Q

What’s Business Continuity Planning?

A

When planning for disaster recovery, you’ll inevitably uncover external risk factors.

34
Q

What’s Business Process Analysis?

A
  • Examine high level business processes.
  • Describe internal low-level processes and external factors that could affect business processes
35
Q

What’s Strategic Risk?

A

Risk of loss due to adverse business decisions, improper implementation of business decisions and lack of responsiveness to changes in the business environment.

36
Q

What’s Operational Risk?

A

Risk of loss from inadequate/failed internal processes, people or systems or from external events.

37
Q

What are the 3 Financial Risks?

A
  • Credit
  • Market
  • Liquidity
38
Q

What is Credit Risk?

A

Risk of loss from a counterparty or issuer to defualt on its obligation.

39
Q

What is Market Risk?

A

Risk of loss from changes in the value of financial instruments.

40
Q

What is Liquidity Risk?

A

Risk a business has insufficient cash flows to meet cash obligations.

41
Q

What happens if a business faces liquidity risk?

A

Becomes insolvent, will suffer losses from borrowing, selling assets at below market value, or paying contractual penalties.

42
Q

Have are internal drivers of risk assessed?

A
  • Risk assessment workshops
  • Discussions with external auditors
  • Stress-testing
  • Scenario analysis
43
Q

What is a Risk assessment workshop?

A

Going through corporate goals, processes and products to uncover risks that could prevent successful implementation or continuation.

44
Q

What are discussions with External auditors?

A

External auditors give advice on potential areas of risk.

45
Q

What is Stress-testing?

A

Varying one input factor at a time.

46
Q

What is Scenario analysis?

A

Constructing a realistic scenario to ask questions about the current situation to uncover risk factors.

47
Q

Which methods are used to reduce levels of business risk associated with developing and launching new products?

A
  • Gap analysis.
  • Market surveys to establish external demand for products.
  • Market research to understand similar products from competitors.
  • Research and development to design the new product.
  • Liaison with external stakeholders, i.e. regulators.
  • ‘Test marketing’ to fine tune the product and its launch.

Risk In Financial Services (3 decks)

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