Chapter Two: Risk Management Flashcards
Identification of types of risk faced by an organization
- Strategic Risk
- Compliance Risk
- Operational Risk
- Financial Risk
4.1. Counter Party Risk
4.2. Political Risk
4.3. Interest Rate Risk
4.4 Currency Risk
4.5 Liquidity Risk
- Strategic Risk
It is a risk in which a company’s strategy becomes less effective and it struggles to achieve its goal.
it could be due to technological changes, a new competitor entering the market, shifts in customer demand, increase in the cost of RM, or any no.of other large-scale changes
- Compliance Risk
Every business needs to comply with rules and regulations
Non compliance leads to penalties in the form of fine and imprisonment
- Operational Risk
It relates to internal risk.
Relates to people as well as process
related to failure on the part of the company to cope with day to day operational problems
- Financial Risk
Referred as the unexpected changes in financial conditions such as prices, exchange rate, credit rating, and interest rate etc.
unexpected political change in any foreign country may lead to country risk which may ultimately may result in financial loss.
4.1. Counter Party Risk
This risk occurs due to non-honoring of obligations by the counter party which can be failure to deliver the goods for the payment already made or vice versa or repayment of borrowings and interest
also covers the credit risk
4.2. Political Risk
faced by overseas investors, as the adverse action by the govt. of host country may lead to huge loses
4.3. Interest Rate Risk
occurs due to change in interest rate resulting in change in A&L
interest rate are in two types - fixed & floating
4.4 Currency Risk
mainly affects the organisation dealing with foreign exchange as their cash flows changes with the movement in the currency exchange rate
this risk can affect CF both adversely or favourably
4.5 Liquidity Risk
defined as inability of organization to meet its liabilities whenever they become due
mainly arises when organization is unable to generate adequate cash or there may be some mismatch in period of cash flow generation
Evaluation of Financial Risk
a. From stakeholders POV - major stakeholders of a biz are equity shareholders and they view financial gearing (ratio of debt in capital structure of co as risk since in event of winding up of a co they will be least prioritised )
b. From Companys POV - if a co borrows excessively or lend to someone who defaults, then it can be forced to go into liquidation
c. From Govt POV - the financial risk can be viewed as failure of any bank or down grading of any FI leading to spread of distrust among society at large even this risk also includes wilful defaulters.
Value At Risk (VAR)
It is a measure of risk of investment.
Features of VAR
- Components of Calculation - (a) Time Period (b) Confidence Level - 95 % and 99% (c) Loss in percentage or in amount
- Statistical Method - based on SD
- Time horizon
- Probability
- Risk Control
- Z Score
Application of VAR
It can be applied
a. to measure the max. possible loss on any portfolio or a trading position
b. as a benchmark for performance measurement of any operation or trading
c. to fix limits for individuals dealing in front office of a treasury department
d. to enable the management to decide the trading strategies
e. as a tool for Asset and Liability Management especially in banks
Counter party Risk
a. Failure to obtain necessary resources to complete the project or transaction undertaken
b. Any regulatory restrictions from the Govt
c. Hostile action of foreign govt
d. Let down by third party
e. Have become insolvent
Techniques to maintain this type of risk
a. Carrying out due diligence before dealing with any third party
b. Do not over commit to a single entity or group or connected entities
c. Know your exposure limits
d. Review the limits and procedure for credit approval regularly
e. Rapid action in the event of any likelihood of defaults
f. Use of performance guarantee, insurance or other instruments
