RISK MANAGEMENT

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WHAT IS RISK?
“The biggest risk is not taking any risk…
In a world that is changing very quickly,
the only strategy that is guaranteed to fail
is not taking risks.”

- Mark Zuckerberg
“Life doesn’t always present you with the perfect
opportunity at the perfect time. Opportunities come
when you least expect them, or when you’re not ready
for them. Rarely are opportunities presented to you in
the perfect way, in a nice little box with a yellow bow on
top… Opportunities, the good ones, they’re messy and
confusing and hard to recognize. They’re risky. They
challenge you.”
- Susan Wojcicki, CEO of Youtube
 Risk management
• Is the process of measuring or assessing risk
and developing strategies to manage it;
• Is a systematic approach in identifying,
analyzing, and controlling areas or events with
potential for causing unwanted change;
• Is the act or practice of controlling risk;
• Includes risk planning, assessing risk areas,
developing risk handling options, monitoring
risks to determine how risks have changed and
documenting overall risk management program
Risk management
(ISO 31000)
• Is the identification, assessment, and
prioritization of risks followed by
coordinated and economical application of
resources to minimize, monitor, and
control the probability and/or impact of
unfortunate events and to minimize the
realization of opportunities
Basic Principles of Risk Management

Create capability
of continual
Be an integral improvement and
part of the enhancement
organizational considering the
process and best available
Create decision-making information and
value human factors

Address Be dynamic, Be systematic,

uncertainty iterative, structured, and
and transparent, continually or
assumptions tailorable, and periodically
responsive to reassessed
change
Process of Risk Management

Identificatio
Establishing n of Risk
the context potential assessment
risks
Establishing the
Context
a. Identification of risk in a selected domain of
interest
b. Planning the remainder of the process
c. Mapping out the following:
i. the social scope of risk management
ii. the identity and objectives of
stakeholders
iii. the basis upon which risks will be
evaluated, constraints

d. Defining a framework for the activity and an

agenda for identification
e. Mitigation or solution of risks using available
technological, human, and organizational
resources
Identification of
potential risk
a. Objective-based risk
b. Scenario-based risk
c. Taxonomy-based risk
d. Common-risk checking
e. Risk charting
Risk assessment

• Assessment of the potential

severity of impact and the
probability of occurrence
• The assessment process is critical
to make the best educated
decisions in prioritizing the
implementation of the risk
management plan
Elements of
Risk Management
01 Identification, characterization,
and assessment of threats

Assessment of the vulnerability

of critical assets to specific
02
threats

03 Determination of the risk (i.e.,

the expected likelihood and
consequences of specific types
of attacks on specific assets)
Identification of ways to reduce
those risks
04
05 Prioritization of risk reduction
measures based on a strategy
Relevant Risk
Terminologies
I. Risks associated with investments
II. Risks associated with manufacturing,
trading, and service concerns
III. Risks associated with financial
institutions
Risks associated
with investments
• Business risk
• Financial risk
• Liquidity risk
• Default risk
• Interest rate risk
• Management risk
• Purchasing power risk
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Business Risk

Get a modern
PowerPoint
refers to the uncertainty about the Presentation that
is beautifully
rate of return caused by the designed.

nature of the business

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Default risk

• Is related to the probability that some or

all of the initial investment will not be
returned
• The degree of default risk is closely
related to the financial condition of the
company issuing the security and the
security’s rank in claims on assets in the
event of default or bankruptcy
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Financial risk

• The firm’s capital structure or sources of

financing determine financial risk. If the
firm is all equity financed, then variability
in operating income is passed directly to
net income on an equal percentage
basis.
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What is operating
leverage?
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Interest rate risk

• Fluctuations in interest rates will cause

the value of an investment to also
fluctuate.
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Liquidity risk

Is associated with the uncertainty created by

the inability to sell the investment quickly for
cash.
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Liquidity risk:
Two uncertainties

1. What price will be received?

2. How long will it take to sell the asset?
vs
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Thin Market

• Occurs when there are relatively few

shares outstanding and investor trading
interest is limited;
• Results in a large price spread (the
difference between the bid price buyers
are willing to pay and the ask price sellers
are willing to accept)
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Management risk

Decisions made by a firm’s management

and board of directors materially affect the
risk faced by investors. Areas affected by
these decisions range from product
innovation and production methods
(business risk) and financing (financial risk)
to acquisitions.
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Purchasing power risk

Is more difficult to recognize than the other

types of risk
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What is the effect of

inflation to investors?
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the real or inflation-

adjusted rate of return <
than the nominal or
stated rate of return
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II. Risks associated with

Manufacturing, Trading,
and Service Concerns
• Product risk • Process stoppage
o Complexity • Health and safety
o Obsolescence • After-sales service failure
o Research and • Environmental
development • Technological
o Packaging obsolescence
o Delivery of warranties • Integrity
• Competitor risk o Management fraud
o Pricing strategy o Employee fraud
o Market share o Illegal acts
o Market strategy
OPERATIONS RISK
MARKET RISK
 • Regulatory change
• Reputation
• Political
• Interest rates volatility
• Regulatory and legal
• Foreign currency
• Shareholder relations
• Liquidity • Credit rating
• Capital availability
• Derivative • Business interruptions
• Viability BUSINESS RISK

FINANCIAL RISK
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III. Risks Associated with

Financial Institutions
 FINANCIAL
• Liquidity risk • Portfolio exposure risk
• Market risk • Derivative risk
• Currency
• Equity
• Commodity

• Credit risk • Accounting information risk

• Counterparty • Completeness
• Trading • Accuracy
• Commercial
- Loans
- Guarantees

• Market liquidity risk • Financial reporting risk

• Currency rates • Adequacy
• Interest rates • completeness
• Bond and equity prices

• Hedged positions risk

 NON-FINANCIAL
• Operational risk • Integrity risk
• Systems • Reputation
- Information processing
- Technology
• Customer satisfaction
• Human resources
• Fraud and illegal acts
• Bankruptcy

• Regulatory risk • Leadership risk

• Capital adequacy • Turnover
• Compliance • Succession
• Taxation
• Changing laws and policies
• Environment risk
• Politics
• Natural disasters
• War
• Terrorism
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POTENTIAL RISK
TREATMENTS
 01
Risk Avoidance
POTENTIAL
02
RISK Risk Reduction
TREATMENTS 03
Risk Sharing

04 Risk Retention
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AREAS OF RISK
MANAGEMENT
 RISK MANAGEMENT SYSTEM TOP MANAGEMENT’S INVOLVEMENT
Oversight activities:

Define goals and objectives, roles

Set management policy, establish context, set
and responsibilities, common
limits and tolerance, etc.
language, and oversight structure
Risk management process:
Step 1: Assess risks Ensure that process captures all business
Identify, source, measure risks
Step 2: Develop/design action
plans: Ensure that all available tools and
Reduce, avoid, retain, transfer, methodologies are used
exploit
Step 3: Implement action plans Review effectiveness of plans; check
capabilities
Step 4: Monitor and report risk Review and evaluate regular reports on
management performance performance
Step 5: Continuously improve risk
management capabilities Evaluate recommendations for improvement
Example:
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SEC Requirement Relative

to Enterprise Risk
Management of Publicly-
listed Corporations
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Risk Management
Framework
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Steps in the Risk

Management Process
1. Set up a separate risk management committee chaired by a board member.
2. Ensure that a formal comprehensive risk management system is in place.
3. Assess whether the formal system possesses the necessary elements.
4. Evaluate the effectiveness of the various steps in the assessment of the
comprehensive risks faced by the business firm.
5. Assess if management has developed and implemented the suitable risk
management strategies and evaluate their effectiveness.
6. Evaluate if management has designed and implemented risk management
capabilities.
7. Assess management’s efforts to monitor overall company risk management
performance and to improve continuously the firm’s capabilities.
8. See to it that best practices as well as mistakes are shared by all.
9. Assess regularly the level of sophistication of the firm’s risk management
system.
10. Hire experts when needed.
3. Assess whether the formal system possesses the necessary elements.
• Key elements of risk management system:
a. Goals and objectives
b. Risk language identification
c. Organization structure, and
d. The risk management process documentation.

• The risk organizational structure should include formal charters, levels of

authorization reporting lines, and job description.
Risk assessment process

a. Assessment risks: identification; determination of their source

b. Development action plans: reduce, avoid, retain, transfer, or exploit
c. Implementation of action plans
d. Monitoring and reporting risk management performance
e. Continuous improvement risk management capabilities