Introduction to Risk Management

U.RAMBABU MBA,MCOM.Assistant Professor

School of Management StudiesLBRCE, Mylavaram

CONCEPT OF RISK

Risk is involved in every activity whether it is of professional ,personal or business. Every individual while doing any activity expects some returns. But it is obvious that the actual returns may never be the same as that of the expected returns .There always exists a difference between the expected and the actual returns. This difference is termed as “RISK”

A probability or threat of damage, injury, liability, loss, or any other negative occurrence that is caused by external or internal vulnerabilities, and that may be avoided through preemptive action.

Finance: The probability that an actual return on an investment will be lower than the expected return

Probability is certain: in a probability of certainty it is not possible to predict the exact out come, but a possible number of outcomes can be known

EX: dice Probability of uncertain: neither exact outcome

nor the number of possible outcomes can be predicted here risk is highly uncertain in nature

ex: floods ,earthquakes, droughts.

DEPENDING UPON THE CONDITION ,RISK IS OF TWO TYPES

Objective risk the proportional change of actual loss

when compared to expected loss is termed as objective risk

Ex: manufacturing company Subjective risk : risk is referred to an

individual’s mental condition or state of mind which is unpredictable

Risk management

Risk management 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 minimize its impact , or cope with its impact

Risk management involves 3 activities Identification of risk Measuring the risk Managing and controlling risk

RISK MANAGEMENT

Identifies loss exposures

faced by an organization.

Highlights the most appropriate

techniques for treating loss

exposures.

Loss exposure is any situation

or circumstance in which loss is

possible.

Objectives of Risk Management:

Pre loss : The firm should prepare for potential

losses in the most economical way. Reduction of anxietyMeet any legal obligation.

Post loss: Survival of the firm Continue operating Stability of earning Continue growth of the firm Minimize effects that a loss will have

on other persons and society.

Elements of Uncertainty

Possibility of result may be upside or down

side.

Adverse result.

Favorable results.

“possibility of outcome being different form

the actual outcome”.

Elements of Uncertainty

Certainty – happening or non-happening of

an event with 100% probability.

Uncertainty – the outcomes are unknown

Risk – number of probable outcome but

nothing is certain and expected.

Elements of Uncertainty

Risk is measurable.

higher the probability higher is the risk.

What is Risk in the present context

Uncertainty of future cash flows.

Sources of Risk

Risk can be either direct or indirect.

Eg: fire destroying the inventory is a direct

damage.

Eg: delay in production or increased

administrative expenses or repair costs are

indirect risks.

Sources of Risk

no knowledge or little knowledge

Trading with borrowed money

Natural calamities (disasters).

change in interest rates.

Stock market fluctuations.

Not following the stop loss orders.

Sources of Risk

Political changes.

Wars.

Damage of reputation.

Mishappenings in operations.

New entrants/substitutes.

Types of Risks:

1. Interest rate risk.

2. Exchange risk.

3. Liquidity risk.

4. Default risk.

5. Internal business risk.

6. External business risk.

7. Financial risk

Types of Risks:

8. Events of god.

9. Market risk

10. Marketability risk

11. Credit risk

12. Personal risk

13. Environmental risk

14. Production Risk

Types of Risks:

Interest Rate Risk:

affects the firm in two ways

1. affecting the profit.

2. affecting the value of its assets or

liabilities.

Eg: floating rate and fixed rate

Types of Risks:

Exchange Risk:

volatility in exchange rates.

exporters are the major sufferers.

Eg: IT comany

Types of Risks:

Liquidity Risk:

Inability to meet financial obligations.

Eg: blocking money in illiquid assets.

Maintenance of working capital.

Types of Risks:

Default Risk:

non-recovery of amount dues from others.

which may lead to inability to pay money to

others.

Types of Risks:

Internal Business Risk:

decision making ability

visualizing future

personnel loss may also come under this

Eg: loosing skilled labours

Types of Risks:

External Business Risk:

factors not in the control of government.

Eg: Delayed monsoons

Fiscal Policy

stability of the government

Types of Risks:

Financial Risk:

level of debt

Smaller the debt smaller is the risk.

reflects in bankruptcy

Types of Risks:

Event of God:

risk completely due to unexpected events.

Eg: fire accidents

strikes

cyclone

earthquake