Enterprise Risk Management

Question 1

What are stakeholders?

Answer 1

There are individuals and companies whose utility depends on how well a firm is doing but who cannot diversify the impact of firm risks on their individual situation. (i.e: workers, suppliers, customers); might be reluctant to make firm-specific investments if they question the firm’s financial health

Question 2

What are shareholders?

Answer 2

They are owners of a firm, they want the firm to be managed in a way that maximizes their welfare.

Question 3

What are ‘costs of financial distress’?

Answer 3

Costs firms incur because of a poor financial situation situation. They can occur even if the firm never files for bankruptcy or never defaults. (Reducing the costs of financial distress is one of the most important benefits of risk management).

Question 4

What benefits are provided to a firm by risk management?

Answer 4

• It does not have to pay bankruptcy costs
• Claimholders (shareholders, debtors) get the firm’s entire cash flow
• In this situation, claimholders’ individual risk management cannot substitute risk management within the firm

Question 5

What is a “Default Put Option”?

Answer 5

When facing the threat of insolvency, shareholders can hold the ‘default put option’; the max amount loss is what they put in, so the amount can never be negative.

Question 6

What is “Asset Substitution Problem”

Answer 6

Investments in projects with negative net present value but with a high return if they are successful.

Question 7

What is the definition of “Risk Management”?

Answer 7

(In the traditional sense, it’s pure risk) A scientific approach to dealing with pure risk by anticipating possible accidental losses and designing and implementing procedures that minimize the occurrence of loss or the financial impact of the losses that do occur.

Question 8

What is the traditional Risk Management Silos?

Answer 8

1) Financial Risk – Treasury
2) Insurance Risk – Risk Management
3) Operational Risk – Business Units

Question 9

What is “ERM”?

Answer 9

Enterprise Risk Management requires an organization to take a portfolio view of risk; this helps take into consideration how individual risks interrelate.

Question 10

What are the 4 categories of the ERM Framework?

Answer 10

1) Strategic: high level goals, aligned with and supporting its mission
2) Operations: effective and efficient use of its resources
3) Reporting: reliability of reporting
4) Compliance: compliance with applicable laws and regulations

Question 11

What is the Sarbanes Oxley Act (SOX 2002)?

Answer 11

Law extends the long-standing requirement for public companies to maintain systems of internal controls

Question 12

What is COSO ERM Cube?

Answer 12

Shows the relationships of all the components of the ERM framework via a three-dimensional cube; 4 objective categories with 8 components.

Question 13

What are some pros of the COSO?

Answer 13

• Helps to evaluate / improve firm’s ERM process
• Provides key principals / concepts
• Creates a common risk language
• Gives clear direction / guidance
• Helps to assess risk appetite / tolerance

Question 14

What are some cons of of COSO?

Answer 14

• Excludes use of RM methods that do not involve ‘explicit’ event ID and risk assessment
• No talk of external environment
• Too large and convoluted
• Not enough of implementation of ERM
• No talk of big data risk, cuber security risk or I.T. risk

Question 15

What are the steps of implementing the Risk Management Process?

Answer 15

1) Determination of objectives
2) Identification of all significant risks
3) Evaluation of potential frequency and severity of risks
4) Development and selection of methods for managing risks
5) Implementing the risk managements methods chosen
6) Monitoring performance and suitability of ERM methods and strategies on an ongoing basis