Risk Management
description
Transcript of Risk Management
RISK MANAGEMENT
Risk
Risky World Food prices spiked in 2008, riots breakout
in more than dozen countries in Africa and Asia, and in Egypt a worker feeding his family with 34$ monthly salary.
In Indonesia a village montie lost one out of five residents when hit by tsunami.
Global financial crises 53 million people will remain stuck in extreme poverty by 2015, who otherwise would not so poor.
Crimes, diseases, loss of employment, war, Terrorist attack……….. World is risky?
Risky World
Risk Risk ‘Uncertainty’ an unexpected
outcome of an event Even the most successful persons
have a bad day in their life Risk can be defined as the
combination of the probability of an event and its consequences (ISO/IEC Guide 73).
Risky worth pursuing
Risk Risk is virtually anything that threatens or
limits the ability of an organization to achieve its mission.
It can be unexpected and unpredictable events such as destruction of a building, the wiping of all your computer files, loss of funds through theft or an injury to a member.
anything can happen, that have the potential to damage your organization, cost you money, or in a worst scenario, cause your organization to close.
8
A risk is ANYTHING that may affect the achievement of an organization’s objectives.
It is the UNCERTAINTY that surrounds future events and outcomes.
It is the expression of the likelihood and impact of an event with the potential to influence the achievement of an organization’s objectives.
Basic principles, concepts, definitions
Source of Risk Risk is based on the uncertainty principle
means that business decisions are subject to the changes in the business environment
constantly changing environment in which organizations exist
In Business only one thing is constant and that is change
Change is not an Event it’s a process that is continuous
Uncertain environment constitutes Customers Technology Govt Regulation Competition
What’s Risk in Change
‘Grow or Die’ (Technology) ‘Stay Connected Stay alive’
(customers) ‘Survival of The fittest’ (Competition) ‘Adapt or Die’ (G. Regulation) The most significant risk to an
organization is the losing touch to its environment
What’s meaning of risk? Who is at risk? What’s source of risk? What’s business environment? What’s risk in change?
Nature of Change Org are living in the turbulent transition
between industrial age and information age Reengineering, revaluation, downsizing,
reinvesting and restructuring all reflect change in business environment
The uncertain environment does not change in a straight line
To know the path of change you have to understand phases of change Forming(Invent,create,try) Norming (repeat,improve,control) Fulfilling(improve quality, reinvent)
The most significant risk to an organization is the losing touch to its environment
13
Basic Concepts
Risky World
In recent years the world have suffered a multitude of crises, financial and economic turmoil have disrupted the world economy through loss of income, jobs, social instability. Natural disasters have devastated entire communities from haiti to japan, there is a trail of fatalities leaving behind a question.
How can we become more resilient to such risks?
Risky World
An other concern is missed development opportunities that arise when necessary risks are not taken.
Inability to mange risk to leads to crises and missed opportunities, risk management calls for people from crises fighters to risk managers.
Risk comes from change…. BUT Solution is not to reject it but to be well
prepared
Risk Effects Risk can effect positively or
negatively, we cal positive effect as opportunity(up side Risk) and negative effect as threat(downside risk).
Risk if ignored can be turn into crises if well managed can be an opportunity
Risk bears some cost in shape of losses if its not managed and it also have some management cost.
Risk can be reduced if not eliminated.
Risk Types
Financial risk Operational Risk Strategic Risk Hazard Risk
Strategic Risks
External Risk Competition
MNC’s vs local Reputatation risk
Media Customer Demand Industry Change
Industry norms change, change in output/input
Internal Risk R&D
low quality products and services
Financial Risks
External Risk Interest Rate Foreign Exchange
Dollar rate effect on imports Credit
Banks credit lines,renewl,reschedule
Internal Risk Liquidity &Cash flow Credit
Non payment by customers
Operational Risks
External Risk Regulation
Compliance risk in Govt rules, taxes introduction of new health and safety legislation
Culture West facing in china
Internal Risk Information System
IT having Flaws, customers see you as unreliable, IT system causes loss of all data.
Supply chain interruptions to your supply chain, reliance on one supplier
Hazard Risks
External Risk Natural Events
Flood, Earthquake, Natural Disaster,
Political and Economical Law and order, Economy slow down, Govt
Destabilization
Internal Risk Properties
Damage to property stock, building,Business inturuptions
Employees Strikes,intruption to production, customer service,Crime
Speculative Risk(Business Risk)
Most business decisions, such as marketing a new product, involve speculative risk.
speculative risk risk that is inherent to a business, involving the chance of either profit or loss
Pure Risk(Hazard Risk)
A natural disaster, such as a flood, or an accident involving a customer or an employee is a pure risk for a business owner.
pure risk the threat of a loss to a business without any possibility of gain, such as robbery or employee theft
The bank call centre
The managers at the call centre of a big commercial bank are reviewing the risks facing the business in the coming year. One issue is that the centre has always had high staff turnover, which is thought to be a result of low pay and demanding shift patterns, along with the high number of similar jobs being offered by other employers in the area.
Highlight Risks
The bank call centre
High staff turnover, low pay and demanding shift patterns, similar jobs being offered Training; It takes about two weeks to familiarize
new recruits with the bank’s product range and IT systems
aware of the processes required for dealing with customers
heavily regulated industry. Reputation Risk Training cost End up with unsatisfied customers(leaving) and
poorly trained, low paid demorale employees(leaving).
Risk Terms
Risk appetite This is the amount of risk an organisation is
willing to accept in pursuit of value. It is directly related to an organisation's strategy and may be expressed as the acceptable balance between growth, risk and return.
Risk culture This is the set of shared attitudes, values and
practices that characterise how an entity considers risk in its daily activities. Risk culture is mainly derived from an analysis of organisational practices, namely rewards or sanctions for risk-taking or risk-avoiding behaviour.
Risk Nature
Risk in the form of uncertain changes in the environment can effect the assets or the management process
The effect of risk also depend upon the types of assets involved and nature of management controls
The assets at risk can be; Human Physical Financial intangible
Risk Nature
Org. Goals
Mgt. Controls
Organization Assets
Risks
ICMAP Mission
Risk Nature
risk involves uncertainty about meeting organizational goals
The only tangible outcome of risk is its consequences we can not see intangibles that are risks
Risk is risk neither good nor bad but its consequences
Consequences depend upon Assets at risk Type of threat Duration of its consequences Controls effectiveness
Risk Nature Risk is a measure of uncertainty on the conditions
of environment, management focuses on consequences of risk
The key to risk assessment lies in the chain of goals and objectives that saturate The organization
Management control system plays an important role in perception of risk, controls minimize consequences of risk and not risk
There are no practical methods for making uncertain events more certain
The management of risk follows the assessment as treatment follows the diagnosis
The management of risk is the essence of management
Risk Analysis It’s a decision making tool for
considering the consequences of alternatives
Why Risk Analysis? To take decisions in business To allocate resources to different projects
Risk analysis include risk assessment and risk management
Risk Assessment is understanding risk and risk management is doing some thing about risk
Risk Analysis Risk Analysis t is a process of thinking
systematically about all possible risks,problems or disasters before they happen and setting up procedures that will avoid the risk, or minimise its impact, or cope with its impact.
It is basically setting up a process where you can identify the risk and set up a strategy to control or deal with it.
Risk Analysis Case study CEO of hexon Organization had to take
a decision, Org in a growth phase and want more space for extended operations, Alternatives
Purchase adjacent land Build an additional facility Build a new building large enough to
handle all operation and sell older one Lease additional facility
Risk Analysis Case study Risk ,uncertainties; External
Market demand(Major) Interest rate Political Risk Compliance risk
What decision can be made Postponing Or taking an alternative of building or Short term arrangements
Who should be involved Every one concerned in his area
Risk assessment and Management
Risk assessment and Management
Risk management is about taking risk knowingly, not unwittingly.”
Risk assessment is a method of identifying and measuring Risk
Risk Management is taking action to minimize Risk
Good risk management is not just about avoiding value destruction - it is also about facilitating value creation.
Risk assessment and Risk Management are tools to help us to understand and solve the problem
Risk assessment
Strategic; conducted for a period of 5 to 10 years by senior management, it includes identification, measurement and prioritization
Project /program/process; use to mange the current period activity , its blend of both strategic and operational
Operational ; used in every day operations largely for health and safety issue, deals with work place risks
Risk assessment
Strategic
Project
Operational
Risk Assessment
Risk Management
Risk Management
Diversify or Avoid the Risk: changing the nature of the activity to spread the exposure over multiple activities
Sharing the Risk: it’s a form of diversification in which risk can be shared with customers, suppliers, or Banks (like Insurance)
Contingency Planning establishing controls for known risks (DRP) Disaster recovery plan
Risk Assessment & Management Risk management process that helps ensure the financial stability and safe operation of an organization. It involves answering three interrelated questions:
1. What are the most significant risks that the organization faces;
2. how are they likely to arise or occur;3. and what can be done about them
either to minimize their potential impact, or otherwise to make proper provision for them?
Risk Assessment & Management Risk assessment and risk management are imprecise tools so we should not expect too much from risk analysis
As Complete security can not b provided so the risks can not be eliminated completely, however key to Risk Management is to insure all the known risks and get a right mix of plans overtime that help you to achieve your goals
43
The Cyclist and the Risk Manager
44
The Cyclist and the Risk Manager
Identify risks that the cyclists faces in cycling to work.
Report back.
45
The Cyclist and the Risk Manager
Identify risks that the cyclists faces in cycling to work.
Report back.
46
RisksThreats: Death Head Injury Injury Reputation Financial Damage to the bike Sunburn/frost bite
Opportunities: Exercise Sunlight Reputation Financial Role model Environment
47
Mitigation Strategies for threats
Death, head injury, other injury – helmet, bright clothes, lights, bell, CANbike course, obeying traffic
laws, positive attitude, anger management course
Reputation – great outfit, change of wrinkle-free clothes, shower, time
management
Financial – high quality locks,stopping at stop signs
Damage to the bike – regular maintenance, avoiding pot holes
Sunburn/frost bite – sunscreen, mittens, hats, token/change
Dehydration- filled water bottle
High risks in Industry The risks of damage to reputation, brand,
and image; network, privacy, and security risks; loss of intellectual property; potential changes in corporate governance, regulatory and legal environment; and fluctuations in economic conditions, were all found to be the top risks in all the sectors of the industry.
High risk with entities that are victim of cyber crime, Banks do not have fraud detection systems that can detect and alert business owners to suspicious or unusual activity in their bank accounts.
Risk Assessment Every entity faces a variety of risks from
external and internal sources that must be assessed. A precondition to risk assessment is establishment of objectives, linked at different levels and internally consistent. Risk assessment is the identification and analysis of relevant risks to achievement of objectives, forming a basis for determining how the risks should be managed.
Because economic, industry, regulatory and operating conditions will continue to change, mechanisms are needed to identify and deal with the special risks associated with change.
Risk Assessment It’s the quantitative and qualitative
evaluation of exposures arising from some activity Risk Identification:
the identification and the classification of what the risk are and their characteristics.
Risk Measurement and Evaluation: the measurement of possible consequences
Risk Prioritization: how the risks are related to each other
Process of risk assessment1. Gain an understanding of the organization's
overall goals Examine documents i.e mission statement Classify into time span of short medium and long term
2. Choose the risks that important to Org. Operational Financial Strategic
3. Define the environment that are important to org. Technology Customer Competitor Economical Financial
Process of risk assessment4. Create a series of matrices5. Using various creative process such
as brain storming, imagine scenarios out of box, may out sourcing.
6. Combine the risk assessment for various goals and objectives. Based on the assessment management can plan how to deal with those risks.
Project risk assessment
Project risk assessment uses a different method to identify risk may use one of the following methods
Exposure analysis; assets involved Environmental analysis; change in
environment Threat scenarios; what is. What
might happen
Project Risk assessment
Identify Risks
Alternatives/ Risk vs Cost
Design Controls
Monitor Risks
Project risk assessment procedure
a) Identify risk; with mentioned approaches
b) Measure Risk/ develop alternatives; measure risk on score scales with different approaches and price out alternatives
c) Control design; choose cost effective controls
d) Risk management; monitor risks and hazards making adjustment to project
Risk Identification
Risks are an everyday part of life, so organisations need a system to identify all those they face. This involves collecting information from a variety of sources: individuals, reports, observation and environmental
assessments. Common methods of collecting data that identify risks include workshops, scenarios, brainstorming and
surveys. These may be linked with consultations with stakeholders, environmental analyses, strategic plans etc.
Risk Identification Risk identification is a key process of Risk
assessment. Risk can not measured, prioritized or managed unless identified
Risk identification sets out to identify an organization's exposure to uncertainty, it requires an intimate knowledge of the organization, the market in which it operates,
the legal, social, political and cultural environment in which it exists, as well as the development of a sound understanding of its strategic and operational objectives,
factors critical to its success and the threats and opportunities related to the achievement of these objectives.
Approaches to identify risk
Exposure Analysis: Managers put physical, financial, human assets at risk to achieve Org. objectives.
• Identification of risks that can effect assets that are critical for any Org. Matrices are created
• Exposure analysis is suitable for asset intensive industries like manufacturing and construction industry
• STPL Size Type portability and location Approach is used.
Risk Identification approaches
Environmental Analysis: the organizations environment constitutes Customer, competitor, economic, Govt Regulations
• the identification of environment risks that could effect organization’s operations
• PEST -- A high level technique to understand the external environment affecting the industry and some of the specific external factors that may affect the business. It considers Political, Economic, Social and Technological factors and the risks to the business that flow from these.
• Suitable for service industry like phone companies
PEST
Risk Identification approaches
Threat Scenarios: specialized risk identification for frauds and disasters
• This approach not frequently used like the above two mentioned Because of time and skills required
• Its always documented and time specific process and its record must keep secure
Risk Identification approaches
Five Forces analysis This technique considers all the forces that influence the company, its industry and its market place. It helps to analyse why a business is successful or not. The five forces are the threat of new entrants, threat of substitute products or services, the bargaining power of suppliers and buyers, the competitors and the intensity of rivalry in the industry.
Facilitated methods (eg, brain storming) have the advantage of drawing upon those experienced in risk assessment, whilst maximising the input of management who should know the business best.
Risk Measurement Assess Risk impact. Once the risks have been
identified, some assessment needs to be made of their likely impact. This involves quantifying the risk in some way. We might conduct market surveys, computer simulations, cost-benefit analyses, or apply probabilities, statistical tests or sensitivity analysis. Alternatively, we may rely on subjective judgments.
Mathematicians prefer to measure it in quant through probability but managers measure it on qualitative scale as low medium and high
Risks are the events with some probability of occurring, consequences are results of risk
Risks and its consequences can be measured on three dimensions
1. Risk occurrence2. Severity of consequences3. The timing of risk and duration of consequences
Risk Measurement
Risk Measurement methods
1. Probability; its application of probabilities to asset values to calculate loss in numbers
The problem with that approach is some situations are difficult to measure in quant way
Take different scenarios of threats like fire, flood and assume probability of threat its duration, assets at risk and expected loss
But most mangers not prefer probability approach
Risk Measurement methods2. Risk Factors are observed; more presence of risk
factors means higher risk; Complexity Asset liquidity Management competence Control strengths
Three types of risk factors used Subjective risk factors
Integrity of management Extent of rapid changes in process
Objective risk factors Value at risk Employee turn over
Calculated risk factors Distance from office
Risk Measurement methods
Weighted matrices: its similar to using risk factors we allocate weights to different components it involve 5 step process1. Limit risk factors2. Choose a scale 1-53. Evaluate factors and assign a score4. Develop weight for each risk factors5. Multiply weight with factor score
Case study The national bank has branches all over
the country and each branch is independent in operations
Source of risk Insider loan activity Collateral verification
controls Every loan secured by collateral Employees loan reported Each collateral loan full documentation and
segregation of authorities Measure risk and allocate 20 hour budget
Case Study Branch Banking
1. Get your scenario?1. Organization type nature, size, of
business goals general/ specific.
2. Source of risk/ categorization/ types of risk , why… explain….
3. Measure/ mapping/ ranking as medium, high or low/ explain…….. Why?
4. What can be done about it… measures why explain…………..
Case Study Branch Banking1. Get your scenario?
Organization type nature, size, of business goals general/ specific. Bank, deals in money, large number of customers, Maximum profit /
fraud prevention & detection of errors
2. Source of risk/ categorization/ types of risk , why… explain… Banks are inherited with risks, Risk of fraud, liquidity risk, interest rate
risk, reputation risk, branch independent risk of abuse of authority. Risks identified relate with revenue, how they constituents total
revenue profit and risk? What are the controls there? Chances of failure of controls. Collateral value decline
3. Measure/ mapping/ ranking as medium, high or low/ explain…….. Why?
Rank the risks with your explanation which you think is comparatively high risk i.e collateral verification
4. What can be done about it… measures why explain………….. Independent Valuation of collateral Decline in collateral value, manual may subject to errors Setting limits of employee loan with respect of time and amount Insider loan Approval from H.O, disclosure in F.S
15 hour budget to Collatral verfication
Risk Prioritization Prioritization is also called ranking; purpose of
ranking is to put relative effort to the various components of the org. based on risks, place more effort on highest risks
Prioritization of identified risks, thereby enabling organizations to improve on project performance by focusing on high-priority risks.
Risk priority is identified using the probability of occurring, the impact on project objectives if realized, as well as time frame and risk tolerance of the project constraints of scope, schedule, cost and quality.
72 Slide 72
Risk Prioritization – likelihood and impact
Likelihood of a risk event occurring Very High: Is almost certain to occur
High: Is likely to occur
Medium: Is as likely as not to occur
Low: May occur occasionally
Very Low: Unlikely to occur
Risk Impact: Level of damage that can occur when a risk event occurs
Very High: Threatens the success of the project
High: Substantial impact on time, cost or quality
Medium: Notable impact on time, cost or quality
Low: Minor impact on time, cost or quality
Very Low: Negligible impact
Methods of prioritization
Absolute ranking; ranked by score in order of magnitude
Relative ranking; ranked as high, medium, low sufficient for general planning purposes
Matrices ranking; components at left and threats at top than rank as H, M ,L
ExerciseThe finance director of xyz has to prepare an
assessment of credit risk to report on board. The company has annual credit sales of Rs. 12 Million and credit terms are 60 days.
Irrecoverable debts 1.5% of total credit sales 10 % of Irrecoverable is recovered through
legal action Required
What is credit risk exposure of the company? What is expected loss each year due to credit
risk?
Risk Management
Process of acting upon the assessment of risk is called Risk management
A prudent management will take steps to manage the risk
Risk Management includes what can be done with the assessed risks
Risk Management
Avoid the Risk: design the process to eliminate particular risks, minimize the risks or change the nature of risks
Control the Risk: introduce procedures to control the process that minimize the consequences and severity of risk occurrence. Pool Risk
Risk of different transactions pooled together Diversification
Share or Transfer the Risk: Burden of risk shared ;through contractual arrangements with suppliers, customers, banks and insurance companies.
Diversification
Diversification is an other method to control risk ‘Don’t check depth of water with both legs’ ‘Don’t put all your eggs in one basket’, spread
risk across investments Change is the source of risk; so select different
investments which change in opposite to each other, which are negatively correlated;
Investments can be from different ranges as; Different Biz sectors week economy to strong economy One country to other country Seasonal to non seasonal
Project Risk management
Risk Rieturn higher Risk Management cost higher
Higher
risk higher
BeginPropos
alRisk
Assessment
Measure Cost of Project
Assessment for high
Risk
Risk Manageme
ntRisk
mang cost
& Risk
Cost of leaving project
Risk retur
n trade
off
Submit 4
Approvaldisap
prove
Cost of Risk
Residual Risk
There is always an amount of risk that left instead of all your management efforts its called residual Risk
If residual risk too high than leave the project if risk not too high than accept it
Risk vs return Inherent risk, control risk, risk of
relying on procedures that can fail to detect
NextNext
Risk Management process
Risk Assessment Risk Assessment
Identify the risksIdentify the risks
Prioritize the risksPrioritize the risks
Measure the riskMeasure the risk
Manage the riskManage the risk
Benefits of Risk Management Risk management helps a company
avoid cost, disruption and unhappiness.
helps management to decide which risks are worth pursuing, and which should be shunned.
benefits of risk management are not easy to quantify as,we can’t say, two major fires, a burglary and three serious accidents prevented
Type of riskBenefits of proactive managementa) Marketing risks
b) Health & safety risks
c) Environmental risks
d) Fire risks
e) Computer
f) Theft and fraud
g) Technical
h) Product contamination
a) Maintain market share
b) Avoid worker litigation; reduce insurance premiums
c) Avoid litigation from regulatory authorities; reduced premiums
d) Avoid loss of production, avoid going out of business; reduced premiums Avoid loss of life or destruction of a building
e) risks Prevent inability to invoice, lack of access to information
f) Prevent loss of money, assets or concepts, loss of market share
g) Avoid being left behind with obsolete manufacturing methods or technologies; avoid production stoppage
h) Avoid harming customers and prevent litigation
Risk management is growing in importance Legislation getting tougher
Company directors can be jailed for corporate offences, and fines can be high for health and safety, product liability & finance issues
Insurance is more expensive and more difficult to get as Insurance companies; putting up premiums For higher risk. adding more exclusions, to the point where the
insurance won’t cover the business require their clients to actively manage their
risks. can’t pay for loss of reputation
Risk management is growing in importance Customer attitudes:
Customer less likely to accept product failure especially for drugs
Shareholders awareness of risk. information in annual reports about the company’s exposure to risk, direct affect on company’s future profits.
Management attitude• Management has learnt from other’s
disaster if want to grow globally they have to be more professional about risk
Fraud
Fraud ‘Whit Collar Crime’, cheating, dishonesty, frogery, embezzlement, insider trading, intentional deception.
Fraud definition; ‘fraud is any intentional act or omission designed to deceive others, resulting in the victim suffering a loss and/or the perpetrator achieving the gain’.
Fraud risk assessment; Inherent fraud risk
Business specific Culture specific
Identify three indicators; Incentive/Pressure Opportunity-control weakness Ability to rationalize
Fraud Risk management FRM required where stakeholders have
greater expectations and regulators have large penalties, Five principles of FRM;1. Governance structure
1. Defined and documented policies and procedures
2. Ethical Culture 1. apply while hiring, promoting employees2. Relationship with customers, suppliers3. Business strategy and operations
2. Fraud Risk Exposure should be assessed periodically
1. Identify indicators as mentioned in above slide
Fraud Risk management3. Feasible prevention techniques to avoid risk
event3. Strong Controls and Communication to all
concerned4. Design Edit Checks in IS5. Cameras and Alarms6. Reconciling accounts7. Employees training8. monitoring
4. Detection and Investigation3. Establish hotlines for complains of stakeholders4. Audit and Inventory count5. Investigation by independent and qualified
personnel
5. Reporting to3. BOD, Legal Authorities.
Counterparty Risk The risk to each party of a contract that the
counterparty will not live up to its contractual obligations. Counterparty risk as a risk to both parties and should be considered when evaluating a contract.
Counterparty risk is the potential exposure any individual firm bears that the second party to any financial contract will be unable to fulfill its obligations under the contract’s specifications.
Counterparty risk has long been one of the major factors that favor the use of exchange-traded rather than over-the-counter derivatives.
In most financial contracts, counterparty risk is also known as "default risk".
Counterparty risk Management The recent market turmoil has reinforced the
importance of adequate risk management, including dealing with exposure to counterparties.
For a new product, the back office facilities need to be developed in order to record the trades and to keep track of the counterparties.
• Some contracts will require the counterparty party to make collateral payments on being downgraded. Does the value of the collateral also decrease?
• Assessment of credit rating that is up to date and accurate?
90
Counterparty risk Management
A master agreement reduce counterparty exposure, as it allows netting. For a new product this provides an incentive to standardize the contract terms (if possible) and develop a master agreement.
A clearing house concentrates exposure – need only worry about the clearing house.
91
IT risk
• Risk Management when applied to information system, this process involves identifying and assessing risks and take appropriate action to manage those risks
• Classifying Risks; risk can be categorized as to the achievement of strategic financial and operational objectives
• Ineffective system design and testing risk from inefficient operations
Political Risk
Political change that alters the probability of achieving business objectives“the risk of a strategic, financial, or personnel loss because of such nonmarket factors as macroeconomic factors (fiscal, monetary, trade, investment, industrial, income), political instability (terrorism, riots, civil war and revolution).”
Seeing negative risk is easier than finding an opportunity
Sources of Political Risk
Confiscation or destruction of overseas assets
Discrimination Restrictions on repatriating cash Price fixing Expropriating assets Restriction on currency conversion Import quotas Company structure Super taxes
political risk Management
Pragmatic usage of contingency planning, intellectual property safeguards, risk diversification, and sound exit planning to guard against Risk
Transfer Risk Borrow locally if foreign investment Participative management
• Share Risk Insurance Joint ventures Negotiate in advance for compensation
Control Risk Hedging diversification
Financial Risks Financial risk is a risk of change in a
financial condition such as exchange rate interest rate credit rating of a customer.
Types of Financial risk1. Credit risk2. Political risk3. Interest rate risk4. Currency risk
Credit Risk
• Credit risk is the risk of non payment or late payment of receivables.
• Due to credit sales Credit Risk is always there in business so need to be managed; Risk of default of borrower, nonpayment or
late payment Controls; Keep amounts and maturities
short Insurance Debt factoring without resource
Currency risk currency risk that arises from possible future
movements of in an exchange rate, its two way risk as exchange rate can move either adversely or favorably. Currency risk of three types
1. Transaction Risk: That is risk is associated with buying and selling in foreign currencies, there is danger that at time of transaction and at time of cash flow exchange rate will fluctuate, it will actually effect cash flow of entity.
2. Translation risk: this risk arises when a company has assets or liabilities denominated in foreign currency. The risk is the exchange rate volatility will cause the value of assets to or liabilities to increase resulting looses to the company.
3. No assets/ liabilities or transaction denominated in foreign currency but it may face economic risk as competitors may be in better position due to favorable exchange rates
Transaction Risk
A Co. purchases goods on six month credit for 150,000$ , exchange rate was 98 Rs./ 1 $. At time of transaction and expected payment?
Suppose the rate changes dollar strengths and now it is 110 Rs/ 1 $.now expected payment?
How much loss?
Transaction Risk Management
Invoice in home currency: transaction can be transferred to customer or supplier if invoice is in home currency
Leading and lagging – making a payment before its due or delaying ; used to hedge against foreign currency fluctuations, this involves changing the timing payments or receivables depending on expected change in exchange rate.
Matching – matching assets and liabilities of the same nature. For example, to hedge against foreign currency movements you would match assets and liabilities denominated in the same currency. Conversely, to protect against movements in interest rates, financing foreign investment with foreign loan.
Transaction Risk Management –Internal Hedging
Netting – Receipts and payments are netted to determine the overall exposure which then can be hedged using external techniques
Pooling; a system of managing cash separate bank balances are pooled together to minimise markup and maximize interest earned
Interest rate risk:
risk that interest rate changes will affect the financial well-being of an entity. This includes changes in interest rates adversely affecting the value and liquidity of fixed or floating rate exposures. In addition to bond prices, interest rate fluctuations also directly affect stock prices, foreign exchange rates and economic growth. Interest Rate
Effect the cost of borrowing Rise in price of funds will effect its movement Effect PV of future cash flows Controls; Diversification
Management
Smoothing – used for interest rate risk management, this involves maintaining a balance between fixed and floating rate debt.
Matching –To protect against movements in interest rates, you would match assets and liabilities having a common interest rate.
Management
Leading and lagging – used to hedge against foreign currency fluctuations, this involves changing the timing payments or receivables depending on changes in foreign currencies.
Netting – assets and liabilities are netted to determine the overall exposure which then can be hedged using external techniques
Management
Manage the risk using external (derivative) hedging techniques such as the use of derivatives (forwards, futures, options, swaps and hybrids of these). This is usually the responsibility of the treasury department.
Risk Management Case Studies
Presentation1. Airline 2. Automotive Retail 3. Healthcare 4. Manufacturing 5. Mining 6. Retail 7. Software 8. Wholesale