risk management — recognized as one of the most uncertainty about the firm's sales and operating POTENTIAL RISK

POTENTIAL RISK TREATMENTS

important competencies needed by the board of expenses. 1.Risk Avoidance— This includes performing an
directors Default risk —is related to the probability that some activity that could carry risk. however, also means
or all of the initial investment will not be returned. losing out on the potential gain that accepting
Risk management — is the of measuring or assessing Financial risk —The firm's capital structure or (retaining) the risk may have allowed.
risk and developing strategies to manage it. sources of financing determine financial risk.
— is a systematic approach in identifying, analyzing Interest rate risk —Because money has time value, 2.Risk reduction or optimization— involves
and controlling areas or events with a potential for fluctuations in interest rates will cause the value of an reducing the severity of the loss or the likelihood of
causing unwanted change. investment to fluctuate also. Although interest rate risk the loss from occurring.
—is the act or practice of controlling risk. includes is most commonly associated with bond price Optimizing risks —means finding a balance between
risk planning, assessing risk areas, developing risk movements, the negative'risk and the benefit of the operation or
handling options, monitoring risks to determine how Liquidity risk — is associated with the uncertainty activity; and between risk reduction and effort applied.
risks have changed and documenting overall risk created by the inability to sell the investment quickly Outsourcing example
management program. for cash.
(1) What price will be received? (2) How long will it 3. Risk sharing --- means sharing with another party
According to International Organization of take to sell the asset? the of loss risk.
Standardization (ISO 31000), Risk Management is
the identification, assessment, and prioritization of thin market— occurs when. there are relatively few 4.Risk retention —involves accepting the loss or
risks followed by coordinated and economical shares outstanding and investor trading interest is benefit of gain from a risk when it Self insurance falls
application of resources to minimize, limited. in this category. All risks that are not avoided are
transferred or by default.
BASIC PRINCIPLES OF RISK MANAGEMENT Management risks— Decisions made by a firm's
(ISO) identifies the basic principles of risk management and board of directors materially affect The Basel II framework breaks risks into market risk
management. the risk faced by investors. from product innovation (price risk), credit risk and operational risk
1. create value resources spent to mitigate risk should and production methods (business risk) and financing
be less than the consequence of inaction, i.e., the (financial risk) to acquisitions. AREAS OF RISK MANAGEMENT
benefits should exceed the costs 1. Enterprise risk management
2. address uncertainty and assumptions Purchasing power risk — is perhaps, more difficult 2. Risk management activities as applied to project
3. be an integral part of the organizational processes to recognize than the other types of risk. It is easy to management
and decision-making observe the decline in the price of a stock or but it is 3. Risk management for megaprojects
4. be dynamic, iterative, transparent, tailorable, and often more difficult to recognize that the purchasing 4. Risk management of information technology
responsive to change power of the return you have earned 5. Risk management techniques in petroleum and
5. create capability of continual improvement and natural gas
enhancement considering the best available II. Risks Associated With Manufacturing, Trading
information and human factors And Service Concerns
6. be systematic, structured and continually or
periodically reassessed A. Market Risk
+Product Risk
PROCESS OF RISK MANAGEMENT Complexity
1. Establishing the Context. This will involve Obsolescence
a. Identification of risk in a selected domain of interest Research and Development
b. Planning the remainder of the process. Packaging
c. Mapping out the following: Delivery of Warranties
i. the social scope of risk management
ii. the identity and objectives of stakeholders +Competitor Risk
iii.the basis upon which risks will be evaluated, Pricing Strategy
constraints. Market Share
d. Defining a framework for the activity and an agenda Market Strategy
for identification. B. Operations Risk
e. Developing an analysis of risks involved in the Process Stoppage
process. Health and Safety
f. Mitigation or Solution of risks using available After Sales Service Failure
technological, human and organizational resources. Environmental
2. Identification of potential risks. Risk Technological Obsolescence.
identification can start with the analysis of the source +Integrity
of problem or with the analysis of the problem itself. Management Fraud
Common risk identification methods are: Employee Fraud
a. Objective-based risk Illegal Acts
b. Scenario-based risk C. Financial Risk
c. Taxanomy-based risk Interest Rates Volatility
d. Common-risk checking Foreign Currency
e. Risk charting Liquidity
Derivative
3. Risk assessment, Once risks have been identified, Viability
their potential severity of impact and the probability of D.Business Risk
occurrence must be assessed. The assessment process Regulatory Change
is critical to make the best educated decisions Reputation
Political
ELEMENTS OF RISK MANAGEMENT Regulatory and Legal
1. identification, characterization, and assessment of Shareholder Relations
threats Credit Rating
2. assessment of the vulnerability of critical assets to Capital Availability SEC Code of Governance Recommendations 2.11
specific threats Business Interruptions "The Board — should oversee that a sound enterprise
3. determination of the risk (i.c. the expected risk management (ERM) framework is in place to
likelihood and consequences of specific types of effectively identify, monitor, assess and manage
attacks on specific assets) key business risks.
4. identification of ways to reduce those risks The risk management framework— should
5. prioritization of risk reduction measures based on a guide the Board in identifying units/business lines
strategy and enterprise-level risk exposures, as well as the
effectiveness of risk management strategies.

Risk management policy —is part and parcel of

a corporation's corporate strategy.

The Board— is responsible for defining the

company's level of risk tolerance and providing
oversight over its risk management policies and
procedures."
I. Risks Associated With Investments
Business risk —refers to the uncertainty about the rate
of return caused by the nature of the business. The
most frequently discussed causes of business risk are Principle 12 —deals with strengthening the
Internal Control System and Enterprise Risk
Management Framework
 documented, clearly communicated, regularly Principles to help avoid pitfalls
Board Risk Oversight Committee (BROC) — that reviewed and monitored.  +Financial expertise must be widely available
should be responsible for the oversight of a company's  +Consider the impact of financial decisions
Enterprise Risk system +Avoiding and mitigating risks  +Avoid weak budgetary control
— should be composed of at least three members, the +Create a Positive Climate for Managing Risk  +Understand the impact of cash flow
majority of whom should be independent directors, +Overcoming the Fear of Risk  +Know where the risk lies
including the Chairman. The Chairman should not be
the Chairman of the Board or of any other committee. non-trading risks— risks that result only in costs:
At least one member of the committee must have These can be thought of as the fixed costs of risk and
relevant thorough knowledge and experience on risk might include property damage risks, legal and
and risk management. contractual liabilities and business interruption risks.

STEPS IN THE RISK MANAGEMENT PRACTICAL CONSIDERATIONS IN

PROCESS MANAGING AND REDUCING FINANCIAL
1. Set up a separate risk management committee RISK
chaired by a board member. Finance— is the lifeblood of a business, heavily
2. Ensure that a formal comprehensive risk influencing strategies and decisions at every level.
management system is in place. —This fully
documented formal system will provide a clear vision 1.Improving Profitability
of the board's desire
3. Assess whether the formal system possesses the A. Variance Analysis - used to monitor and manage
necessary elements. the results of past decisions, assess the current
situation and highlight solutions.
The key elements that the company-wide risk B. Assessment of Market Entry and Exit Barriers
management system should possess are — include the need to compete with businesses that
a) goals and objectives enjoy economies of scale, or established differentiated
b) risk language identification products.
c) organization structure and Other barriers include capital requirements, access to
d) the risk management process documentation. distribution channels, factors independent of scale
C. Break-even Analysis
The risk organizational structure should include The break-even point— is when sales cover costs,
formal charters, levels of authorization reporting lines where neither a profit nor a loss is made.
and job description.
Break-even analysis— (cost-volume-profit or CVP
The risk management process shall include the analysis) is used to decide whether to continue
following steps: developing a product, alter the price, provide or adjust
a) Assessment risks: Identification; Determination of a discount, or change suppliers to reduce costs. It is
their source. also helps in managing the sales mix, cost structure
b) Development actions plans: Reduce, avoid, retain, and production capacity, as well as in forecasting and
transfer or exploit budgeting.
c) Implementation of action plans
d) Monitoring and reporting risk management
performance.
e) Continuous improvement risk management
----continuation of steps D. Controlling Costs
4. Evaluate the effectiveness of the various steps in the  Focus on the big items of expenditure.
assessment of the comprehensive risks faced by the  Be cost aware— Casualness is the enemy of cost
business firm. control.
5. Assess if management has developed and  Maintain a balance between costs and quality.
implemented the suitable risk management strategies  Use budgets for dynamic financial management—
and evaluate their effectiveness. Budget early so financial requirements are known
as soon as possible.
risk profile— highlights all the significant possible  Develop a positive attitude to budgeting.
risks  Eliminate waste
6. Evaluate if management has designed and Practical Techniques to Improve Profitability
implemented risk management capabilities.
 Focus decision-making on the most profitable
7. Assess management's efforts to monitor overall
areas.
company risk management performance and to
 Decide how to treat the least profitable products.
improve continuously the firm's capabilities.
8. See to it that best practices as well as mistakes are  Make sure new products enhance overall
shared by all. This involves regular communication of profitability.
results and feedbacks to all concerned.  Manage development and production decisions.
9. Assess regularly the level of sophistication of the  Set the buying policy.
firm's risk management system.  Consider how to create greater value from existing
10. Hire experts when needed. customers and products to enhance profitability.
 Consider how to increase profitability by managing
people.
CHAP 12  Avoiding Pitfalls

5 MOST SIGNIFICANT TYPES OF RISK

CATALYST
1.Technology. New hardware, software or system
configurations
2. Organizational change. new management
structures or reporting lines, new strategies
3. Processes. New products, markets and acquisitions
4. People. Hiring new employees, losing key people,
poor succession planning,
5. External factors. Changes to regulation and
political, economic or social

APPLY A SIMPLE RISK MANAGEMENT

PROCESS
A. Risk Assessment and Analysis
—It is more difficult to assess the risks inherent in a
business decision than to identify them. Can also be
solved through past experiences
B. Risk Management and Control
— Risk should be actively managed and given a high
priority across the whole organization. Risk
management procedures and techniques should be well