SU4 - The ERM Process - Stage 4 - Risk Evaluation

Question 1

Explain the purpose of the Risk Evaluation stages.

Answer 1

The risk evaluation stage will evaluate the financial impact (loss or gain) of a risk in a business in numerical terms.

Question 2

What is the process outputs of the Risk Evaluation Stage.

Answer 2

1. Sensitive analysis
2. Quantitative schedule and cost risk analysis results
3. Decision tree
4. Scenario modelling
5. Investment model results
6. Revised risk register

Question 3

What are the Process Mechanisms used in the Risk Evaluation Stage

Answer 3

1. Probability trees
2. Expected monetary value (EMV) - expected return calculation
3. Utility Theory and functions.
4. Decision Trees
5. Markov Chain - combines probabilities with matrix algebra
6. Investment appraisal

Question 4

What are the Process Activities that can be conducted in the Risk Evaluation Stage?

Answer 4

1. Basic concepts of Probability
2. Sensitivity Analysis
3. Scenario analysis
4. Simulation
5. Monte Carlo simulation
6. Latin hypercube sampling
7. Probability distributions defined from expert opinion

Question 5

Explain the meaning of Basic Concept of Probability.

Answer 5

It is used by a business to measure, expected outcomes for mutually exclusive and non-mutually exclusive events.

Example of mutually exclusive:
Group of companies=
40 Public companies (40/100)
30 Private Companies (30/100)
30 Partnerships (30/100)

Question 6

Explain the sensitivity analysis.

Answer 6

When you are evaluating the profitability of an investment proposal by taking a single variable and examine the effects of changes in selected variable.

Question 7

Explain simulation.

Answer 7

It is a method used to analyse financial or time models, where the the variables, such as risks, opportunities, costs and duration, are uncertain.

This method can only be used if the company has the statistical software.

Question 8

Explain the Monte Carlo Simulation.

Answer 8

It provides a way of evaluating the effect of uncertainty on a planned activity in a wide range of situations.

This method can be used to evaluate costs, duration and demand.

Question 9

What are the benefits of the Monte Carlo Simulation?

Answer 9

1. It is simple to develop
2. It can be extended as the need arises.
3. It is readily available and can be used to automate the tasks involved in the simulation.
4. PC’s can be used to calculate the activity outcome quickly
5. Can accommodate a great # of distributions without difficulty
6. Basic maths used in simulation
7. Greater level’s of precision can be achieved by increasing the number of iterations.
8. Complex spreadsheet functions can be included
9. Results obtained can be investigated with ease

Question 10

Explain the Latin Hypercube Sampling.

Answer 10

It is designed to accurately recreate the probability distributions specified by distribution functions in fewer iterations than Monte Carlo Sampling.

It creates a cumulative probability Distribution Curve for each variable.