Module 5 Flashcards
It can be defined as the probability or likelihood of occurrence of losses relative to the expected return on any particular investment.
Risk
T or F. Risk is an uncertain event that may have
T
RISK may be viewed as:
- ____________ that potentially come with __________ and __________ that have to be borne as a consequence of DANGER.
- Therefore, the lesser the risk in a given investment, the ______________.
- It can also be said that, no risk, ________.
- Therefore, Risk should not be totally ______, instead we should understand risk in order to manage them effectively.
- HIGHER REWARDS; OPPORTUNITY; Higher Risks
- lesser the opportunity for gain
- no reward.
- avoided
These are faced by a company from
within its organization and arise during the normal operations of the company. These are human,
technologic, and physical factors.
Internal Risks
It comes up due to economic events that arise from outside a company’s organization. These are economic, natural and political factors.
External Risks
Risk Management Strategies and Processes
- Risk Identification
- Risk Analysis
- Risk Assessment and Evaluation
- Risk Mitigation
- Risk Monitoring
Company identifies and defines potential risks that may negatively influence a specific company process or project.
Risk Identification
The goal of analysis is to further understand each specific instance of risk, and how it could influence company’s project and objectives.
Risk Analysis
Risk is further evaluated and company will make the decision if its acceptable based on its risk appetite
Risk Assessment and Evaluation
Company develops a plan to alleviate them using specific risk
controls such as risk prevention tactics and contingency plans.
Risk Mitigation
The overall plan to continuously monitor and track new and existing risks. The overall risk management process should also be reviewed and updated accordingly
Risk Monitoring
4 Risk Management Approaches
- Risk Avoidance
- Risk Reduction
- Risk Sharing
- Risk Retaining
This strategy is designed to deflect as many threats as possible in order to avoid the costly and disruptive consequences of a damaging event.
Risk Avoidance
It is the reduction of the amount of effect certain risks can have on company processes. This is achieved by adjusting certain aspects of on overall project or by reducing its scope.
Risk Reduction
The consequences of a risk being shared, or distributed among several of the project’s participants. It could also be a third party, such as vendor or business partner.
Risk Sharing
Companies decide if a risk is worth it from a business standpoint, and decide to retain the risk and deal with any potential fallout.
Risk Retaining
The higher the risk, the higher the rewards
The lower the risk, the lower the reward
Risk – Reward Trade Off
Types of Risk Associated with Securities
- Systematic Risk
- Unsystematic Risk
Systematic Risk vs. Unsystematic Risk
Systematic Risk
- uncontrollable by an organisation
- macro in nature
- Market-related risk
- External in nature
**Unsystematoc Risk
- controllable by an organisation
- micro in nature
- Company specific risk
- Internal in nature
Systematic Risk
- Interest Rate Risk
- Market Risk
- Purchasing Power/Inflationary Risk
- Arises due to variability in the interest rates from time to time.
- The volatility of bond prices that result from changes in interest rates.
- It particularly affects debt securities as they carry the fixed rate of interest.
Interest Rate Risk
- Associated with consistent fluctuations seen in the trading price of any particular share or securities.
- also known as Position Risk is defined as the risk to which a Broker Dealer is exposed to and arising from securities held by it as principal or in its proprietary or dealer account.
Market Risk
The risk that the value of your money in real terms will be less than the purchasing power of your original investment.
Purchasing Power Risk/
Inflationary Risk
Purchasing Power Risk/
Inflationary Risk
– Demand Inflation Risk
– Cost Inflation Risk
risk arises due to increase in prices, which result from an excess of demand over supply.
Demand Inflation Risk
arises due to sustained increase in the prices of goods and services.
Cost Inflation Risk
Unsystematic Risk
– Business Risk / Liquidity Risk
– Financial Risk / Credit Risk
– Operational Risk
Risk that an investment may not find a ready buyer or that it may have to be disposed at a substantial loss.
Business Risk/Liquidity Risk
Business Risk/Liquidity Risk
– Asset Liquidity Risk
– Funding Liquidity Risk
means that risk that an entity will be unable to unwind a position in a financial instrument at or a near its market value because of the lack of depth or disruption in the market for that instrument.
Asset Liquidity Risk
means the risk that an entity cannot obtain the necessary funds to meet its obligations as they fell due at normal times and during crisis.
Funding Liquidity Risk
- also known as DEFAULT RISK.
- This refers to the “creditworthiness” of the issuer and expected ability to pay interest and repay the principal.
Financial Risk/Credit Risk
Financial Risk/Credit Risk
– Large Exposure Risk
– Counterparty Risk
– Settlement Risk
Credit Rating Table
page 467-468 SL deck
means risk to which a Broker Dealer is exposed whether by way of:
a. a proportionally large amount of exposure to particular counterparty;
b. a proportionally large exposure to a single issuer of debt;
or
c. a proportionally large exposure to a single equity security or single issuer group.
Large Exposure Risk
exist when counterparty does not deliver a security or its value in cash as per agreement of trade or business.
Settlement Risk
means the risk of a counterparty defaulting on its financial obligation to a Broker Dealer
Counterparty Risk
- It is the risk not inherent in financial, systematic or market-wide risk.
- It is the risk remaining after determining financial and systematic risk, and includes risks resulting from breakdowns in internal procedures, people and systems.
Operational Risk
Risk that foreign exchange rates will change
Currency Risk (Market Risk)
Risk that commodity prices will
change.
Commodity Risk (Market Risk)
risk of investment in a particular sector.
Sector Risk
Liquidity Risk is the risk that an investment may not find a ready buyer. To reduce this risk, avoid the following:
- Don’t have a ready market
- Are not listed
- Are listed but not actively traded
- Are very volatile
refers to the ability of the bond issuer to pay interest and repay debt.
Credit / Default Risk
risk of inflation
Purchasing Power Risk
risk that future bond proceeds will have to be reinvested at lower rates.
Reinvestment Risk
possibility that a bond will be called by the Issuer before its maturity date.
Call Risk
events that may result in a decline in the value of investment or inability to liquidate its investment in the country where the money is invested.
Country / Geographic Risk
operations are subject to various regulations that may affect accounting of assets, valuation of securities, taxes, etc
Regulatory Risk
associated with all actively managed forms of investments.
Management Risk
arising from the execution of a company’s business function.
Operational Risk
involves having an excess level of debt that increases the ratio of the market value of debt to the market value of equity.
Financial Leverage Risk
any event that results in a negative perception towards the company by clients, distributors, and other stakeholders.
Reputation Risk
experiencing rating downgrades.
Rating Agency Risk
mergers and acquisitions present strategic pricing, regulatory, transaction cot, and due diligence risk.
Merger and Acquisition Risk
the amount by which the rate of return on a risky investment exceeds the rate of return on a less risky investment. The extra return on the risky investment compensates the investor for taking on risk.
Risk Premium
the rate of return on an investment with zero risk. T-Bills can be used to approximate the risk-free rate as these investments are said to be risk-free.
Risk–Free Rate
is the business function used to plan, organize and control all available resources to reach company goals.
Management
the systematic process of managing an organization’s risk exposure to achieve its objective.
Risk Management
T or F. Risk Management is a set of coordinated activities to direct and control an organization with regard to risk.
T
T or F. It deals with the identification, assessment and various strategies that help mitigate the adverse effects of risk on the organization.
T
What is the Purpose of Risk Management?
- To mitigate the loss of property and increase the success chance of the organization.
- To identify potential events that may affect the entity and manage risks to be within its risk appetite in order to provide reasonable assurance regarding the achievement of entity objective.
- To achieve maximum sustainable value from all the activities of the organization.
- Enhances the understanding of the potential upside and downside of the factors that can affect an organization.
- Increases the probability of success and reduces both the probability of failure and the level of uncertainty associated with achieving the objectives of the organization.
Statistical and Pricing Models
- Value at Risk (VaR)
- Capital Asset Pricing Model (CAPM)
modeling is an assessment of the amount of potential loss, the probability of occurrence for the amount of loss and the time frame.
Value at Risk (VaR) -
model that describes the relationship between the systematic risk and expected return for assets.
Capital Asset Pricing Model (CAPM)
The company identifies and defines potential risks that may negatively influence a specific company process or project.
a) Risk Identification
b) Risk Assessment
c) Risk Evaluation
d) Risk Analysis
a) Risk Identification
The risk strategy that is designed to accept the risk and deal with potential fallout.
a) Risk Reduction
b) Risk Avoidance
c) Risk Sharing
d) Risk Retaining
d) Risk Retaining
It is also know as the undiversifiable risk.
a) Systematic Risk
b) Market Risk
c) Equity Risk
d) Systemic Risk
a) Systematic Risk
The model is an assessment of the amount of potential loss and its probability of occurrence
a) CAPM
b) VaR
c) Risk-based Model
d) Risk Management Process
b) VaR
The rate of return on an investment with zero risk is called
A) Risk Premium
B) Risk-Free Rate
C) Risk-Reward Trade Off
D) Rating Agency Risk
B) Risk-Free Rate
Steps in a Sound Risk Management Process
A-T-M
1. Assess
2. Treat
3. Monitor
ATM Framework* Inspections and audits
ASSESS
1. Recognition and Identification of Risks
2. Evaluation and Ranking of Risks
TREAT
3. Responding to significant Risks
4. Resourcing Controls
5. Reaction Planning
MONITOR
6. Reporting and Monitoring Risk Performance
7. Reviewing the Risk Management Framework
Risk identification establishes the exposure of the organization to risk and uncertainty. This requires an intimate knowledge of the following:
- organization;
- the market in which it operates;
- the legal, social, political and cultural environment in which it exists; and
- an understanding of strategic and operational objectives.
Risk analysis activity assists the effective and efficient operation of the organization by ________________ that require attention by management.
The result of the risk analysis can be used to ______________. It provides a tool for prioritizing risk treatment efforts.
identifying those risks; produce a risk profile
analysis of processes and operations within the organization to identify critical components that are key to success
Flowcharts and dependency Analysis
Methods of Risk Identification:
- (SWOT) Analysis
- Flowcharts and dependency Analysis
- Questionnaires and checklists
- Workshops and brainstorming
- Inspections and audits
Collection and sharing of ideas and discussion of the events that could impact the objectives, stakeholder expectations or key dependencies
Workshops and brainstorming
Use of structured questionnaires and checklists to collect information to assist with the recognition of the significant risks
Questionnaires and checklists
Physical inspections of premises and activities and audits of compliance with established systems and procedures
Inspections and audits
is presented in ISO 31000 as the activity of selecting and implementing appropriate control measures to modify the risk.
Risk treatment
Responding to Significant Risks
- AVOID OR ACCEPT
- REDUCE/CONTROL/MITIGATION
- TRANSFER
- EXPLOIT
Risk treatment includes as its major element, ________________, but extends further to, for example, _________, _________, ___________________.
Any system of risk treatment should provide _________________.
risk control (or reduction); risk avoidance; risk retention; risk transfer and risk exploitation
efficient and effective internal controls
REDUCE/CONTROL/MITIGATION
- Control risk through internal processes or actions that reduce the likelihood of undesirable events occurring to an acceptable level
AVOID OR ACCEPT
- Divest by exiting a market or geographic area, or by selling, liquidating or spinningoff a product group.
- Eliminate at the source by designing and implementing internal preventive processes.
- Accept risk at its present level taking no further action
- Re-price products/services by including a premium (if market condition allows)
TRANSFER
- Insure through cost-effective contract with independent, financially capable party under a well-defined risk strategy
- Hedge risk by entering in to capital markets
- Share risks/rewards of investing in new markets and products by entering into alliances or joint venture
EXPLOIT
- Expand business portfolio by investing in new industries and geographic areas
- Reorganize processes through restructuring, vertical integration, outsourcing and re-engineering
- Redesign the company’s business model
as the final step involves understanding the impact of the control mechanisms developed on the hazard and the risk it poses.
Monitoring and Review
T or F. Monitoring and review ensures that the organization
monitors risk performance and learns from experience.
T
