Module 1 - Unit 4 Risk Assessment 1: Introduction And Identification

Question 1

How would you define Risk Assessment?

Answer 1

The overall process of risk identification, risk analysis and risk evaluation

Question 2

What is Risk Perception?

Answer 2

When assessing risk is important to be aware that different individuals in an organisation may hold different risk perceptions, known as “expert judgements”

Question 3

What are the 3 risk assessment considerations?

Answer 3

Risk Identification
- What might happen?

Risk Analysis
- How likely is to happen?
- If it does, what might be the impact?

Risk Evaluation
- So what?
- Is it within our risk appetite and tolerance?

Question 4

What is VaR?

Answer 4

VaR is a measure of the potential loss in a portfolio over a given time horizon within a given confidence interval.
X - probability or percentage (confidence level we are seeking)
V - value at risk (the amount we expect to lose)
T - time period we are considering

Question 5

What is expected shortfall?

Answer 5

Expected shortfall, sometimes called ‘expected tail loss’ it is defined as the average loss that could occur in excess of the loss calculated by VaR over a time period and using the same confidence level. Expected shortfall overcomes VaR limitations.

Question 6

What is stress test?

Answer 6

Stress testing and scenario analysis provide alternative to VaR and other risk measures. They explore reactions to small (sensitivity) or drastic (stressed) changed in conditions.

Question 7

Stress testing and scenario analysis techniques are being used for:

Answer 7

• Assessing capital and liquidity requirements
• Understanding the dynamics of the risk environment and therefore providing a tool for decision making
• Challenging the output of VaR or other models
• Informing senior management

Question 8

How are risks classified?

Answer 8

Risks are classified as:
• short-term - risks with imediate impact (operational activities or market changes)
• medium-term - in bank reporting medium term is between 1-3.5 yrs
• long-term - in bank reporting over 3-5 yrs

Question 9

What is Monte Carlo simulation?

Answer 9

Monte Carlo simulation is a model used to predict the probability of different outcomes when the intervention of random variables is present.

Question 10

Explain the top down risk

Answer 10

A top down risk assessment exercise tends to focus on risks related to strategy, tactics operations and complicance (STOC)

Question 11

Explain the bottom-up risk

Answer 11

A bottom-up risk assessment tends to focus on risks identified as compliance, hazards, control and opportunity.

Question 12

What is the variance - co variance method? (Known as the Risk Metrics approach)

Answer 12

Variance is a measure of the variability or spread in a set of data (e.g., market returns)

Covariance is a measure of the extent to which corresponding elements from two sets of data move in the same direction.
• results are normally distributed
• correlations between risk factors are constant
• sensitivity to changes of risk factors is constant

Question 13

What is the historical method?

Answer 13

The historical method re-organised actual historical returns.

Question 14

What is the Reverse Stress Testing?

Answer 14

The stress tests start from the point at which the businss plan becomes unviable. The process is intended to drive an understanding of what might bring a business down.

Question 15

What is the BOW-TIE tool?

Answer 15

The bow-tie tool purpose is to demonstrate that sources of risk can lead to events that have consequences. The diagram helps to focus on the precise nature of each risk and provides a logical basis for analysing the context, causes and consequences.

Question 16

What is PESTLE?

Answer 16

PESTLE is a risk classification system for calssifying risk from the organisation’s EXTERNAL CONTEXT

Political
Economic
Social
Technological
Legal
Environmental

Question 17

What is the FIRM scorecard?

Answer 17

The FIRM scorecard classifies risks as:
Financial
Infrastructure
Reputational
Marketplace

Risks are derived:
Internally (e.g.,staff fraud) - FINANCIAL AND INFRASTRUCTURE RISKS
Externally (e.g., exchange rate valiability) - REPUTATIONAL AND MARKETPLACE RISKS

Question 18

What are the advantages/disadvantages of top down risk?

Answer 18

Advantages:
• Likely to result in an Enterprise wide approach
• Most significant strategic risks can be captured quickly
• Shows management buy in
• Likely to encourage consistent methodology

Disadvantages:
• Senior Managers more focus on external risk
• Limited awareness of internal operational risk or interdependencies
• Danger that the approach becomes superficial because senior managers believe they can manage crises
• New emerging risks from the operational activities might not be fully identified

Question 19

What are the advantages and disasvantages of bottom up risk?

Answer 19

Advantages:
• Buy in at all levels
• Can be mirrored to an existing organisation chart and risk impacts beyond immediate operational risks can be discussed
• Operational staff have good awareness of local risks which may not be visible to senior management
• Methodology can be varied to suit norms and culture.

Disadvantages:
• Little focus on external or strategic risks
• Time consuming and may demotivate
• Danger that the approach becomes too detailed leading to silo approach
• New risks emerging from the operational activities might not be reported by operational staff

Question 20

What are the three reasons that organisations clasify risks?

Answer 20

1. To provide structure to the process of risk identification
2. Helps with the development of consistent risk terminology
3. Enables the organisation to collect together similar risk types throughout the organisation.

Question 21

Give examples of 4 Assessment Techniques:

Answer 21

Questions & Checklists
Workshop & Brainstorming
Inspection & Audits
Flow Charts

Question 22

What are the advantages/disadvantages of using Questionnaires & Checklists to undertake risk assessment.

Answer 22

Advantages:
• Consistent structure guarantees consistency
• Greater involvement than in a workshop

Disadvantages:
• Rigid approach may result in some risks being missed
• Questions will be based on historical knowledge

Question 23

What are the advantages/ disadvantages of using Workshops and Brainstorming to undertake risk assessment.

Answer 23

Advantages:
• Consolidated opinions from all interested parties
• Greater interaction produces more ideas

Disadvantages:
• Senior management tends to dominate
• Issues will be missed if incorrect
people involved

Question 24

What are the advantages/ disadvantages of using Inspections and Audit to undertake risk assessment.

Answer 24

Advantages:
• Physical evidence forms the basis of opinion
• Audit approach results in good structure

Disadvantages:
• Inspections are most suitable for hazard risks
• Audit approach tends to focus on historical experience

Question 25

What are the advantages/disadvantages of using Flow charts to undertake risk assessment.

Answer 25

Advantages:
• Useful output that may be used elsewhere
• Analysis produces better understanding of processes

Disadvantages:
• Difficult to use for strategic risks
• May be very detailed and time-consuming

Question 26

5 Financial Services risk classifications

Answer 26

• Credit Risk - (e.g., counterparty failure to pay)
• Market Risk - (e.g., losses in on and off balance sheet position due to movements in marketplace)
• Liquidity Risk - (e.g., bank unable to settle obligations immediately)
• Operational Risk - (e.g., failed internal processes, people, systems etc.)
• Insurance Risk - (e.g., underwriting risk, claims management risk)

Question 27

5 types of STRESS TESTING

Answer 27

• sensitivity test (where firma changes factors in its models such as corelations or rates)
• historical events (historical event in the past if ocurres today)
• customised events (making up an event that didn’t occur)
• multiyear stress tests (understand the impact of a cash flow)
• reverse stress test (understand what might bring a business down)