Risk management project
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Chapter1-RISK1.pptxInstructor- Dr.Riyaz Muhmmad
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MGT202
Introduction to Risk Management
Chapter 1
RISK
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Definition of Risk
“Risk” may be defined as a compound measure of the probability and magnitude of adverse effect.
A risk is a potential problem – it might happen and it might not
Conceptual definition of risk
Risk concerns future happenings
Risk involves change in mind, opinion, actions, places, etc.
Risk involves choice and the uncertainty that choice entails
Two characteristics of risk
Uncertainty – The risk may or may not happen, that is, there are no 100% risks (those, instead, are called constraints)
Loss – The risk becomes a reality and unwanted consequences or losses occur
One of the earliest references to the concept of risk management in literature appeared in the Harvard Business Review in 1956.
Someone within the organization should be responsible for “managing” the organization’s pure risks. At the time that the term risk manager was suggested, many large corporations had a staff position referred to as the “Insurance Manager.”
Instructor- Dr.Riyaz Muhmmad
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History of Risk
Derived from the Italian word ‘rischio’, meaning a source of peril, this everyday word is defined by the Oxford English Dictionary thus;
A situation involving exposure to danger.
The possibility that something unpleasant will happen.
A person or thing causing a risk or regarded in relation to risk: a fire risk.
Instructor- Dr.Riyaz Muhmmad
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What is Risk?
To the layman, the term ‘hazard’ and ‘peril’ appear to be synonymous with ‘risk’. In fact meanings are distinct:
Hazard: A hazard is something probability of a risk occurring.
Peril: if the risks is physical damage a building, then fire, storm, flood and earthquake are all perils
Instructor- Dr.Riyaz Muhmmad
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The Language of Risk
Perils and Hazards
In risk management, a peril is the direct or immediate cause of a loss (such as a fire or automobile crash)
A hazard is a condition that increases the possible frequency or severity of a loss, or both
Moral hazard: deceit, often involves insurance
Morale hazard: carelessness
Physical hazard: tangible conditions (snow, ice)
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Risk Categorization in Business
Known Risks
Those risks that can be uncovered after careful evaluation of the project plan, the business and technical environment in which the project is being developed, and other reliable information sources (e.g., unrealistic delivery date)
Predictable risks
Those risks that are extrapolated from past project experience (e.g., past turnover)
Unpredictable risks
Those risks that can and do occur, but are extremely difficult to identify in advance
Weak Economies: GDP growing slowly.
Regulatory Risk: Rules can change at a moment’s notice.
Increasing Competition: Increased competition from local and foreign firms.
Damage to Reputation: Corruption and bad press can destroy a company’s image.
Failure to Attract Top Talent- Due to Downsizing Policy of HR
Failure to Innovate- lack of proper Budget for research & Development
Business Interruption- Strike and lock out
Commodity Price Risk- Due to variable cost
Cash Flow & Liquidity Risk- Banking and financial institution
Political Risk: Middle East politics lowering the price of oil
Instructor- Dr.Riyaz Muhmmad
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Unpredictable risks
‘Risk is the inability to accurately predict the effects of future events which might result in losses.’
Risk or danger is present whenever human beings are unable to control or foresee the future with certainty.
Although, the precise future outcome is unknown, the possible alternatives can be listed; such as "heads” or “tails”.
The chances associated with those possible alternatives are also known; such as a 50% (50 percent) chance of either “heads” or “tails”.
Instructor- Dr.Riyaz Muhmmad
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The Nature of Risk
Fundamental Risks-These tend to affect large numbers of people, perhaps areas of countries, or whole countries, or even a number of countries or a geographical region.
For example, cannot be controlled or influenced by individual action. Incidences of volcanic eruption, tidal waves and tsunami, floods, earthquakes, and similar “natural”
Another example of fundamental risk is the economy of a country. That is because the effects of, say, “inflation” or mass unemployment, are beyond the influence of individuals.
Instructor- Dr.Riyaz Muhmmad
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Types of Risks
Particular Risks- These refer to risks whose future outcomes or effects can be partially controlled (although not predictably) by individuals or groups of people .
For example, from an individual’s decision to drive a motor vehicle, or to own property, or even to cross a road. Much depends on the individual’s action and level of care (or lack of care and attention).
Particular risks are the responsibility of individuals,
such risks are ‘insurable’.
Instructor- Dr.Riyaz Muhmmad
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Types of Risks
The majority of insurable risks are what are called ‘pure risks’ which include fire, accidents, theft, etc, which offer no prospect of gain, but only of loss if the risk becomes a reality.
Trading risks are called ‘speculative risks’ because they offer the possibility of loss or gain, and in general they are not insurable.
Instructor- Dr.Riyaz Muhmmad
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Pure Risks and Speculative Risks
Examples of Pure vs. Speculative Risk Exposures
Pure Risk: potential loss but no possible gain
Physical damage to property from fire, flood or other natural disasters
Liability risk: getting sued over products; employment practices
Individual risk of mortality or morbidity
Manmade risks: war; unemployment
Global pandemics; social program failure
Speculative risk: potential gain or loss
Market risk: interest rate fluctuation, foreign exchange volatility, stock price
Reputational risk
Brand risk
Individual credit risk
Regulatory changes
Accounting risk
Diversifiable vs. Non-diversifiable Risks
Diversifiable risks: risks whose adverse consequences can be mitigated simply by having a diversified portfolio of risk exposures
Non-diversifiable risks: risks, shared by all persons or organizations, that cannot be mitigated by adding exposures to the portfolio
Examples of Diversifiable and Non-Diversifiable risks
Diversifiable Risks
Reputational risk
Brand risk
Credit risk
Product risk
Legal risk
Physical damage risk
Operational risk
Strategic risk
( A kind of MICRO risks)
Non-diversifiable Risks
Market risk
Regulatory risk
Environmental risk
Political risk
Inflation and recession risk
Pandemics,
Social security program risks
( A kind of MACRO risks)
Statistical measures that are historical predictors of investment risk and volatility and major components in Modern Portfolio Theory (MPT). MPT is a standard financial and academic methodology for assessing the performance of a stock or a stock fund compared to its benchmark index.
Volatility refers to the amount of uncertainty or risk.
According to the MPT theory, it's possible to construct an "Efficient Frontier" of optimal portfolios offering the maximum possible expected return for a given level of risk
'Benchmark’-When evaluating the performance of any investment, it's important to compare it against an appropriate benchmark.
Instructor- Dr.Riyaz Muhmmad
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DEFINITION of 'Risk Measures'
There are five principal risk measures: Alpha: Measures risk relative to the market or benchmark index Beta: Measures volatility or systemic risk compared to the market or the benchmark index R-Squared: Measures the percentage of an investment's movement that are attributable to movements in its benchmark index Standard Deviation: Measures how much return on an investment is deviating from the expected normal or average returns Sharpe Ratio: An indicator of whether an investment's return is due to smart investing decisions or a result of excess risk.
Instructor- Dr.Riyaz Muhmmad
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Principal Risk Measures
The risk inherent to the entire market or an entire market segment.
Systematic risk, also known as “Un-diversifiable Risk,” “volatility” or “market risk,” affects the overall market, not just a particular stock or industry.
Instructor- Dr.Riyaz Muhmmad
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Systematic Risk
This type of risk is both unpredictable and impossible to completely avoid. It cannot be mitigated through diversification, only through hedging or by using the right asset allocation strategy.
Sources of Systematic Risk
Interest rate changes, inflation, recessions and wars all represent sources of systematic risk because they affect the entire market.
Instructor- Dr.Riyaz Muhmmad
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Sources of Systematic Risk
Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.
Beta is used in the capital asset pricing model (CAPM), a model that calculates the expected return of an asset based on its beta and expected market returns.
Instructor- Dr.Riyaz Muhmmad
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How systematic risk is measured?
The capital asset pricing model (CAPM) is a model that describes the relationship between systematic risk and expected return for assets, particularly stocks.
CAPM is widely used throughout finance for the pricing of risky securities, generating expected returns for assets given the risk of those assets and calculating costs of capital.
Instructor- Dr.Riyaz Muhmmad
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'Capital Asset Pricing Model - CAPM'
A risk pool is one of the forms of risk management mostly practiced by insurance companies.
Under this system, insurance companies come together to form a pool, which can provide protection to insurance companies against catastrophic risks such as floods, earthquakes etc.
The term is also used to describe the pooling of similar risks that underlies the concept of insurance.
Risk pooling is an important concept in “Supply Chain Management”.
It measures by either the standard deviations or the coefficient of variation
Instructor- Dr.Riyaz Muhmmad
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Risk Pooling
