Introduction to Risk Management

Risk: Risk means something can turn out differently to what you expected. It is the possible variation
in an outcome from what is expected to happen. Risk may be upside or downside, pure or speculative.
Uncertainty is the inability to predict the outcome from an activity for lack of information
Risk for the business: Risks faced by businesses in general are as follows:
Risk that trade conditions might be poor, sales might fall or cost might rise
Risk that inadequate control within the business may result losses through inefficiency
Risk of financial natures
Attitudes toward risk
1. A risk averse: tries to avoid risk and satisfies with lower return
2. A risk neutral: Tries to take risk according to the expected return, irrespective of risk
3. A risk seeker: wants to take more risk to have more return
Expected return: it is the weighted average of return, weight being the probability of the scenarios
from which the return will generate. [Mathematical problem with Expected Return]
Risk classifications:
Risk
Business Risk
Strategy
Enterprise
Product
Economic
Technology
Property

Non Business risk

Finance Risks
Credit
Market
Liquidity
Gearing
Default
Foreign Exchange
Interest rate
Market

Operational risk
Process
People
systems
legal
Event
Disaster
Physical
Regulatory
Social
Reputation or Political
Systematic
Legal
Economic
Operating

Scale of risk or risk concept:

The scale of a risk for a business depends upon four key risk concepts
a. Exposure- is a measure of the way in which a business is faced by risk. A transport company
is more risk exposed to operational risk of human injury than a bank/ accounting firm
b. Volatility is how the factor to which a business is exposed is likely to alter: For example, a
rice producer is dependent on good weather, fashion business are subject to change of taste.
c. Impacts- is the measures of the amount of loss if undesirable outcomes occurs. Impacts may
be measured in monitory terms, days in delays, injuries, etc.
d. Probability- means how likely is that a particular outcome will occur
Greater risk will arise at high exposure, volatile underlying factors, severe impacts & high probability
Risk management
Risk management is the identification, analysis and economic control of risk which threaten the assets
or earning capacity of a business.
Purpose of risk management is to understand and then to minimize exposure of risk and adverse
effect of risk
By reducing probability of the risk occurring
By limiting the impact they will have on the business
Why risk management is necessary?

There may be legal requirement to manage risk (risk based management approach by
Bangladesh Bank for Financial institutions)
This may be required by licensing authorities or regulatory bodies
Financial organization may require risk management
Risk Management Process: (Figures in book)
1. Risk awareness & Identifications: This is identifying whole range of possible risks and
likelihood of losses arising for the risk. It is a continuous process bases on awareness and
knowledge that potential new risks may arise and existing risk may change. There are two
approach of identifying risk top down approach & bottom up approach
2. Risk analysis (assessment & measurement)- This is a process of identifying the probability of
the risk occurring and quantifying the impact by calculating the amount of potential loss using
expected value of gross risks.
3. Risk response & Control: Here the risk can be avoided (do not do the risky activity), reduced
(by strictly controlling process), shared (e.g., with a insurer) or simply accepted (risk retention)
4. Risk Monitoring & reporting: Monitoring should be continuous, on going process such that if
the risky event does occur then the action taken should include an immediate review of the
management of risk. So, Monitoring is a form of control
Crisis Management: Crisis is an unexpected event that threatened the wellbeing of a business or a
significant disruption to business which impacts on its customers, employees, and other stakeholders.
Crisis management is identifying a crisis, planning a response to the crisis and confronting and
resolving the crisis.
Types of crisis
In terms of their effect: Financial Crisis, Public relation crisis and strategic crisis
In terms of their causes: Natural event, industrial accident, product/ service failure, public relation
disaster, business crisis, management crisis, legal & regulatory crisis.
Managing a crisis:
Crisis prevention- by planning ahead and projection likely outcomes
Contingency planning- The business should make a contingency plan for the worst
Effective action in the event of crisis
1. assess objectively the cause
2. Determine whether crisis have short term/long term effect
3. Project most likely course of event
4. Focus resources on activities that mitigate the crisis
5. Look for opportunities
Disaster recovery
Disaster is a major crisis or event which causes a breakdown in the businesss operations and
resultant losses. A business need to recover from a disaster as quick as possible
Examples for reduction and sharing risk of a disaster
A fire safely plan (site preparation, detection, extinguisher, training to employees)
Waterproof ceilings and floors with adequate drainage
Physical access control- to counter threats from terrorist.
Sensible attitude to behavior
A long term disaster recovery plan will typically provide for
Standby procedures
Recovery procedures
Personnel management

Questions from this chapter:

1. Define and differentiate risk and uncertainty. It is known that a particular project will yield
either a profit of CU100,000 or a loss of CU50,000. The profit will arise with a
probability of 0.8 and the loss will arise with a probability of 0.2. Indicate whether the
said project is risk or uncertainty.

2.
3.
4.
5.
6.
7.

What are the attitudes towards risk? Calculation of expected returns

Describe classification of risk
What is risk management? Why you will do risk management?
Describe the risk management process.
What is crisis? How you will manage a crisis?
Interactive questions

Introduction to financial information

Why is business finance important?
Finance plays a central role in a business, so financial information does as well. For the following
reasons, business finance is important
Most of the business stakeholders have a financial interest in the business
Primary objective of a business is a financial one
Finance is a separate function in the organizational structure
How much finance the business needs and how this can be raised determine the legal form it
takes
Business finance strategy is one of the strategy central to its overall corporate strategy.
Business are exposed to financial risk
Why business and managers need financial information?
The activity in which Business and manager require financial information are given below with
example of information required in the activity
1. Planning- Planning requires knowledge of available resources, possible time scale for
implementation and likely outcome under alternative scenarios
2. Controlling- Whether implementation is as per plan or whether there is unexpected deviation
3. Recording transactions- Information required are documentation of transaction, detailed
information of the costs, source materials for a transaction
4. Performance measurement- Information required are costs, revenues, volumes, etc.
5. Decision making- Relevant information for decision making
Qualities of good information (ACCURATE)
1. Accurate
2. Complete
3. Cost-beneficial
4. User-targeted
5. Relevant
6. Authoritative
7. Timely
8. Easy to use
Sources of data & information
Internal data sources
External data sources
Accounting records
The internet
Human resources and payroll records
The government
Machine logs and computer system in production
Advice or information bureau
Timesheets in service businesses
Consultancies
Staff
Newspaper and magazine publishers
The system of other business via EDI
Libraries or information services
How data or information is processed? (Information system)
Environment
System boundary
Environment

Input (Data)

Processing

Output (Information)

In relation to financial information, there are two information processing system we use mainly
1. The transaction processing system (TPS) It is a system which performs, records and
processes routine transaction. It is used for routine tasks

2. Management information system: converts data from mainly internal sources into information
(e.g., summary report, exception report). This information enables managers to make timely
and effective decisions for planning, directing and controlling the activities.
3. Expert system allows users to benefit from expert knowledge and information. The system will
consist of a database holding specialized data and rules about what to do, or how to interpret,
a given set of circumstances. Business applications for the system are legal or tax service,
project management, economic forecasting, diagnostic systems, etc. Conditions when expert
system are most useful are as follows:
The problem is reasonable well defined
The expert can define some rule by which the problem can be solved
The problem cannot be solved by conventional transaction processing
The expert could be released to more difficult problems
The investment in the system is cost-justified
Information security: information Security is the protection of data from accidental threats which
might cause unauthorized modification, disclosure or destruction of data and the protection of the
information system from the degradation or non-availability of services
Security involves prevention, detection, deterrence of problems plus recovery and correction
procedures and threat avoidance
Physical access control
1. Personal control by guard or reception
2. Door lock
3. Lock with keypad system or card entry system
4. Intruder alarm
5. Laptop and other computer with access control.
6. Personal identification number
Integrity control
Data verification (ensuring data entered matches with source documents)
Data validation (Check digit, control total, range check, limit check, etc.)
Processing control to ensure accuracy & completeness of processing
Output control
Back up or archive strategy
Password control
Segregation of duties
Users of financial information:
1. Present & potential investors
2. Employees
3. Customers
4. Suppliers and other business partners
5. lenders
6. Government and its agencies
7. The public at large
Limitations of financial information
1. Conventionalized representation
2. back-ward locking
3. Omission of non-financial information
Questions from the chapter
1. What is financial information? Why finance is important.
2. What information will a manager or business use in planning, controlling, transaction recording
performance measurement and decision making?
3. Write the limitation of the information system.
4. Write the qualities of good information
5. Define information system. Please explain briefly about the information system.
6. Define expert system. Whet this can be needed? What are the pre-requisites of the expert
system.
7. What is information security? How we can ensure the information security?
8. State the users of financial information
9. Interactive questions