1. www.notes638.wordpress.com L1: Introduction to Risk Management
BBK3253 | Risk Management
Prepared by Dr Khairul Anuar
L1: Introduction to Risk Management

2. Assessment
Two assignments
Assignment 1 -individual 30%
Assignment 2 –individual 30%
Final exam 40%
100%
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3. What is Risk?
Risks are uncertain future events that could influence the achievement of an organisation’s objectives, including strategic, operational, financial and compliance objectives.
Events are potential incidents or occurrences resulting from internal/external sources that effect implementation of strategies or achievement of objectives.
Events can be both positive and negative.

4. Organizational Objectives
Organizational objectives are:
Reliable financial reporting.
Efficiency and Effectiveness of operations.
Safeguarding of assets.
4. Compliance with laws and regulations.

5. Business or operational risks
Examples of Risks
Examples of Risk
Non-compliance
Fraud
risks
Business or operational risks
Reputational
risks
Environmental
Financial
risks

6. Examples of Risks
Business or operational risks: related to activities of business-functions
Financial risks: relating to financial operations.
Environmental Risks: related to changes in the political, economic, social and financial environment.
Reputational Risks: a threat or danger to the good name or standing of a business or entity.

7. 1. Business or Operational Risk
Relates to activities carried out within the company arising from structures, systems, people, products or processes.
In banking, BASEL committee on banking supervision defined it as the risk of loss resulting from inadequate or failed internal processes, people, systems and external events.

8. 1. Business or Operational Risk
It includes business interruptions, errors or omissions, product failure, health and safety, failure of IT system, fraud, loss of key people, litigation, loss of suppliers etc.
Generally within control of the company through risk management practices including internal controls and insurance

9. 2. Financial Risk
Financial risk is an umbrella term for any risk associated with any form of financing.
Typically, in finance, risk is synonymous with downside risk and is intimately related to the shortfall or the difference between the actual return and the expected return (when the actual return is less)
Financial risks arise from an organization’s exposure to financial markets, its transactions with others, and its reliance on processes, systems, and people.

10. 2. Financial Risk
Financial risk arises through countless transactions of a financial nature, including
sales and purchases,
investments and loans, and
various other business activities.
It can arise as a result of legal transactions, new projects, mergers and acquisitions, debt financing. the energy component of costs, or through the activities of management, stakeholders, competitors or foreign governments.

11. 2. Financial Risk There are three main sources of financial risk:
Financial risks arising from an organization’s exposure to changes in market prices, such as interest rates, exchange rates, and commodity prices.
Financial risks arising from the actions of, and transactions with other organizations such as vendors, customers, and counterparties in derivatives transactions
Financial risks resulting from internal actions or failures of the organization, particularly people, processes, and systems.

12. 2. Financial Risk
Organizations manage financial risk using a variety of strategies and products.
It is important to understand how these products and strategies work to reduce risk within the context of the organization’s risk tolerance and objectives.

13. 2. Types of Financial risk
Interest Rate Risk
Foreign Exchange Risk
Commodity prices Risk
Credit Risk
Liquidity Risk

14. 2.1 Interest Rate Risk
Interest rates are a key component in many market prices and an important economic barometer. They are comprised of the real rate plus a component for expected inflation, since inflation reduces the purchasing power of a lender’s assets.
Higher risk=higher interest rate
The greater the term to maturity, the greater the uncertainty.
Interest rates are also reflective of supply and demand for funds and credit risk.

15. 2.1 Interest Rate Risk
Interest rates are particularly important to companies and governments because they are the key ingredient in the cost of capital.
Most companies and governments require debt financing for expansion and capital projects.
When interest rates increase, the impact can be significant on borrowers. Interest rates also affect prices in other financial markets, so their impact is far-reaching.

16. 2.1 Interest Rate Risk
Other components to the interest rate may include a risk premium to reflect the creditworthiness of a borrower.
For example, the threat of political or sovereign risk can cause interest rates to rise, sometimes substantially, as investors demand additional compensation for the increased risk of default.

17. 2.2 Foreign exchange rates
Foreign exchange rates are determined by supply and demand for currencies.
Supply and demand, in turn, are influenced by factors in the economy, foreign trade, and the activities of international investors, capital flows, given their size and mobility, are of great importance in determining exchange rates.

18. 2.2 Foreign Exchange Risk
Factors that influence the level of interest rates also influence exchange rates among floating or market-determined currencies.
Currencies are very sensitive to changes or anticipated changes in interest rates and to sovereign risk factors. Some of the key drivers that affect exchange rates include:
Interest rate differentials net of expected inflation
Trading activity in other currencies
International capital and trade flows
International institutional investor sentiment
Financial and political stability
Monetary policy and the central bank
Economic fundamentals

19. 2.3 Commodity prices risk
Physical commodity prices are influenced by supply and demand.
Unlike financial assets, the value of commodities is also affected by attributes such as physical quality and location.

20. 2.4 Credit Risk
Credit risk is an investor's risk of loss arising from a borrower who does not make payments as promised.
Such an event is called a default. Another term for credit risk is default risk.
Higher credit risk reduce value of securities.
It increases as time to maturity, settlement or expiry increases.
Organizations are exposed to credit risk because of business and financial transactions

21. 2.4 Credit Risk-examples
Investor losses include lost principal and interest, decreased cash flows and increased collection costs which arise in a number of circumstances:
A consumer does not make a payment due on a mortgage, credit card, line of credit or other loan.
A business does not make a payment due on a mortgage, credit card, line of credit, or other loan
A business or consumer does not pay a trade invoice when due.
A business does not pay an employee's earned wages when due
A business or government bond issuer does not make a payment on a coupon or principal payment when due.
An insolvent insurance company does not pay a policy obligation
An insolvent bank won't return funds to a depositor.

22. 2.5 Liquidity Risk
Asset Liquidity - risk that a given security or asset cannot be traded quickly enough in the market to prevent a loss (or make the required profit).
Funds Liquidity - Risk that liabilities cannot be met when they fall due.
Liquidity risk arises from situations in which a party interested in trading an asset cannot do it because nobody in the market wants to trade that asset.
Liquidity risk becomes particularly important to parties who are about to hold or currently hold an asset, since it affects their ability to trade.

23. 3. Reputational Risk
A threat or danger to the good name or standing of a business or entity.
Reputational risk can occur through a number of ways:
directly as the result of the actions of the company itself;
indirectly due to the actions of an employee or employees; or
tangentially through other peripheral parties, such as joint venture partners or suppliers.
In addition to having good governance practices and transparency, companies also need to be socially responsible and environmentally conscious to avoid reputational risk.

24. Risk classification
Grouping of different risks according to their estimated cost or likely impact, likelihood of occurrence, countermeasures required, etc.
Example: credit risk is classified according to the likelihood of the collection or accounts.
There is no one widely accepted set of categories, it can vary according to the nature of business and its industry.
List of risks can be endless.

25. Advantages of risk classification
By grouping risks, they can be managed in common by use of similar controls.
Categorization forces managers to be more proactive for managing risks.
Categorization helps manager to use their past experience applied to one category before.

26. Advantages of risk classification
This provides a framework that can be used to define who is responsible, design controls and assist in simplified and consistent risk reporting.
It can help identify which risks are inter related.
Use of framework ensure risk management activities are focused.