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Understanding Risk Management Strategies

There are two main types of risks - systematic risk which cannot be reduced by diversification, and diversifiable risk which can be reduced through diversification. Risks include financial risks like credit and market risk, and non-financial risks like operational and reputational risks. Risk management frameworks help identify, monitor, mitigate, assess, and address risks. The benefits of risk management include reducing earnings volatility, maximizing shareholder value, and promoting job security. Key aspects of risk management are exposure, volatility, probability, severity, time horizon, and capital allocation. The risk management process involves risk awareness, measurement, and control strategies to optimize risk and return.

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46 views2 pages

Understanding Risk Management Strategies

There are two main types of risks - systematic risk which cannot be reduced by diversification, and diversifiable risk which can be reduced through diversification. Risks include financial risks like credit and market risk, and non-financial risks like operational and reputational risks. Risk management frameworks help identify, monitor, mitigate, assess, and address risks. The benefits of risk management include reducing earnings volatility, maximizing shareholder value, and promoting job security. Key aspects of risk management are exposure, volatility, probability, severity, time horizon, and capital allocation. The risk management process involves risk awareness, measurement, and control strategies to optimize risk and return.

Uploaded by

Mitchell Nathaniel
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd

Risks

The probability of something happening that might jeopardize achieving the


objective.
Systematic risk -> cannot be reduced by diversification. A common risk that
is inherent in the system.
Diversifiable risk -> risk that can be reduced by diversification by
combinations of several distinctive risks.

Types of Risks
Financial Risk: Credit risk (risk of failure of counterparty, supplier to meet
their obligation), market risk (risk of negative consequences due to
movement in prices), and liquidity risk
Non Financial Risk: Operational risks (risk of its people, system, processes, or
that of external events), strategic or business risks, application or
implementation risks, contagion and related party risk, competition risk,
reputational risks, and so on.
Hazard risk and underwriting risks: Hazards -> fire, natural perils, crime,
injury and underwriting risk refers to mispricing.

Risk Management Framework is the company way of work with regards to


identifying, monitoring, mitigate, assess, and deals with risks.

Risk Management is the approach to manage the impact of risks in order


to achieve objectives.

Benefits of Risks Management


1. Managing risk is managements job; not of the shareholders, they only
elect management.
2. Managing risk can reduce earnings volatility
3. Managing risk can maximize shareholders value
4. Managing risk promotes job and financial security; one with higher skills in
risk management more likely to retain their jobs, others lose their job and
an opportunity to take.

Risks concepts:
1. Exposure; worst that could possibly happen
2. Volatility
3. Probability
4. Severity; damage likely to be suffered
5. Time horizon
6. Correlation
7. Capital
Allocation of economic capital to business units has two important
business benefits:
a. Those with more risks need to compensate by generating greater
profit
b. Profitability of business units can be compared on consistent risk
adjusted basis

Risk Management Process


1. Risk awareness
a. Set the tone from the top; commitments from the board
b. Ask the right question;
i. Key questions that senior management should ask; Return,
Immunization (limits or control to minimize the the downside),
System, Knowledge
c. Establish a risk taxonomy
d. Provide training and education
e. Link compensation to risks
2. Risk measurement; risk report should consist of:
a. Losses; those above threshold, total losses relative to revenue and
volume, actual losses vs. expected/budgeted levels
b. Incidents; potential impact, root causes, and business response,
emerging trends, significant patterns
c. Management assessments of potential risks
d. Risk indicators; early warning indicators to allow management to
take pre-emptive action to mitigate potential risks
3. Risk control strategies; ultimate objective is to optimize risk/return. Three
fundamental ways of doing this:
a. Selective growth of the business
i. Discuss key issues at an early stage, develop fair and
objective criteria
ii. Allocating corporate resources to business activities with the
highest risk adjusted returns
b. Support profitability; price of any product should reflect the cost of
its underlying risks as well as more traditional costs -> risk adjusted
pricing
c. Control downside risks; business is about taking risks, not to
eliminate risks but to control them within an acceptable range.
i. Stop loss limits; amount of losses an institution can incur
before triggering further treatment
ii. Sensitivity limits; amount of potential losses that
management does not wish to exceed -> avoid concentration
of risks
4.

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