FM 11-9

Risk Management
GBS FOR WEEK NO. 02 & 03
Period Covered: ____________________________

SCHOOL YEAR _________________ | ________ Semester

OBJECTIVES:

After working in this material, the learner is expected to:

1. Explain the nature and definition of risk

2. Distinguish between pure risk and speculative risk.

3. Identify the major pure risks that are associated with financial insecurity

4. Understand how risk is a burden to society

5. Explain the major methods of handling risk.

6. Learn several different ways to split risk exposures according to the risk types involved (pure versus speculative,
systemic versus idiosyncratic, diversifiable versus nondiversifiable).

7. Differentiate several different ways to split risk exposures according to the risk types involved (pure versus
speculative, systemic versus idiosyncratic, diversifiable versus nondiversifiable).

CORE LESSON CONTENTS:

Nature of Risk and Losses Opportunities

Risk management is the identification, assessment, and prioritization of risks (defined in ISO 31000 as the effect of
uncertainty on objectives) followed by coordinated and economical application of resources to minimize, monitor, and
control the probability and/or impact of unfortunate events or to maximize the realization of opportunities. Risks can
come from uncertainty in financial markets, threats from project failures (at any phase in design, development,
production, or sustainment life-cycles), legal liabilities, credit risk, accidents, natural causes and disasters as well as
deliberate attack from an adversary, or events of uncertain or unpredictable root-cause. Several risk
management standards have been developed including the Project Management Institute, the National Institute of
Standards and Technology, actuarial societies, and ISO standards. Methods, definitions and goals vary widely according
to whether the risk management method is in the context of project management, security, engineering, industrial
processes, financial portfolios, actuarial assessments, or public health and safety.

The strategies to manage threats (uncertainties with negative consequences) typically include transferring the threat to
another party, avoiding the threat, reducing the negative effect or probability of the threat, or even accepting some or
all of the potential or actual consequences of a particular threat, and the opposites for opportunities (uncertain future
states with benefits).

Certain aspects of many of the risk management standards have come under criticism for having no measurable
improvement on risk, whether the confidence in estimates and decisions seem to increase. For example, it has been
shown that one in six IT projects experience cost overruns of 200% on average, and schedule overruns of 70%.Most risk
professionals define risk in terms of an expected deviation of an occurrence from what they expect—also known

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as anticipated variability. In common English language, many people continue to use the word “risk” as a noun to
describe the enterprise, property, person, or activity that will be exposed to losses. In contrast, most insurance industry
contracts and education and training materials use the term exposure to describe the enterprise, property, person, or
activity facing a potential loss. So a house built on the coast near Galveston, Texas, is called an “exposure unit” for the
potentiality of loss due to a hurricane. Throughout this text, we will use the terms “exposure” and “risk” to note those
units that are exposed to losses.

Definition of Risk

1. 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.

2. Finance: The probability that an actual return on an investment will be lower than the expected return. Financial risk
is divided into the following categories: Basic risk, Capital risk, Country risk, Default risk, Delivery risk, Economic risk,
Exchange rate risk, Interest rate risk, Liquidity risk, Operations risk, Payment system risk, Political risk, Refinancing risk,
Reinvestment risk, Settlement risk, Sovereign risk, and underwriting risk.

3. Food industry: The possibility that due to a certain hazard in food there will be an negative effect to a certain
magnitude.

4. Insurance: A situation where the probability of a variable (such as burning down of a building) is known but when a
mode of occurrence or the actual value of the occurrence (whether the fire will occur at a particular property) is not. A
risk is not an uncertainty (where neither the probability nor the mode of occurrence is known), a peril (cause of loss), or
a hazard (something that makes the occurrence of a peril more likely or more severe).

5. Securities trading: The probability of a loss or drop in value. Trading risk is divided into two general categories: (1)
Systemic risk affects all securities in the same class and is linked to the overall capital-market system and therefore
cannot be eliminated by diversification. Also called market risk. (2) Nonsystematic risk is any risk that isn't market-
related or is not systemic. Also called nonmarket risk, extra-market risk, or unsystemic risk.

6. Workplace: Product of the consequence and probability of a hazardous event or phenomenon. For example, the risk of
developing cancer is estimated as the incremental probability of developing cancer over a lifetime as a result of exposure
to potential carcinogens (cancer-causing substances).

Distinguish Between Pure Risk and Speculative Risk

Pure Risk

Situation where there is a chance of either loss or no loss, but no chance of gain; for example either a building will burn
down or it won't. Only pure risks are insurable because otherwise (where the chance of the occurrence of a loss is
determinable) insurance is akin to betting and the insured may stand to gain from it a situation contrary to the most
fundamental concept of insurance. Also called absolute risk.

A category of risk in which loss is the only possible outcome; there is no beneficial result. Pure risk is related to events
that are beyond the risk-taker's control and, therefore, a person cannot consciously take on pure risk.

For example, the possibility that a person's house will be destroyed due to a natural disaster is pure risk. In this
example, it is unlikely that there would be any potential benefit to this risk.

There are products that can be purchased to mitigate pure risk. For example, home insurance can be used to protect
homeowners from the risk that their homes will be destroyed.

Other examples of pure risk events include premature death, identity theft and career-ending disabilities.

Speculative Risk

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A category of risk that, when undertaken, results in an uncertain degree of gain or loss. All speculative risks are made as
conscious choices and are not just a result of uncontrollable circumstances. By definition, almost all investment activities
involve speculative risks, as an investor has no idea whether an investment will be a blazing success or an utter failure.
However, some investments are more speculative than others. For example, investing in government bonds has much
less speculative risk than investing in junk bonds, because government bonds have a much lower risk of default.

Speculative risk is the opposite of pure risk.

Pure vs. Speculative Risk

Pure Risk: There are only two possibilities; something bad happening or nothing happening. It is unlikely that any
measurable benefit will arise from a pure risk. The house will enjoy a year with nothing bad occurring or there will be
damage caused by a covered cause of loss (fire, wind, etc.). Predicting the outcomes of a pure risk is accomplished
(sometimes) using the law of large numbers, a priori data or empirical data. Pure risk, also known as absolute risk, is
insurable.

Speculative Risk: Three possible outcomes exist in speculative risk: something good (gain), something bad (loss) or
nothing (staying even). Gambling and investing in the stock market are two examples of speculative risks. Each offers a
chance to make money, lose money or walk away even. Again, do not equate gambling and investing on any other level
than as both being a speculative risk. Gambling is designed to enrich one party (the house); the odds are always in its
favor. Investing is designed to enrich all involved, the house that set up the “game” AND those that chose to place
money in the game – all participants with “skin in the game” win or lose together. Speculative risk is not insurable in the
traditional insurance market; there are other means to hedge speculative risk such as diversification and derivatives.

Table 1.2 Examples of Pure versus Speculative Risk Exposures

Speculative Risk—Possible Gains

Pure Risk—Loss or No Loss Only or Losses

Physical damage risk to property (at the enterprise level) such as caused by Market risks: interest risk, foreign
fire, flood, weather damage exchange risk, stock market risk

Liability risk exposure (such as products liability, premise liability, employment Reputational risk
practice liability)

Innovational or technical obsolescence risk Brand risk

Operational risk: mistakes in process or procedure that cause losses Credit risk (at the individual enterprise
level)

Mortality and morbidity risk at the individual level Product success risk

Intellectual property violation risks Public relation risk

Environmental risks: water, air, hazardous-chemical, and other pollution; Population changes
depletion of resources; irreversible destruction of food chains

Natural disaster damage: floods, earthquakes, windstorms Market for the product risk

Man-made destructive risks: nuclear risks, wars, unemployment, population Regulatory change risk
changes, political risks

Mortality and morbidity risk at the societal and global level (as in pandemics, Political risk
social security program exposure, nationalize health care systems, etc.)

Accounting risk

Longevity risk at the societal level

Genetic testing and genetic

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 Speculative Risk—Possible Gains
Pure Risk—Loss or No Loss Only or Losses

engineering risk

Investment risk

Research and development risk

Within the class of pure risk exposures, it is common to further explore risks by use of the dichotomy of personal
property versus liability exposure risk.

Personal Loss Exposures—Personal Pure Risk

Because the financial consequences of all risk exposures are ultimately borne by people (as individuals, stakeholders in
corporations, or as taxpayers), it could be said that all exposures are personal. Some risks, however, have a more direct
impact on people’s individual lives. Exposure to premature death, sickness, disability, unemployment, and dependent old
age are examples of personal loss exposures when considered at the individual/personal level. An organization may also
experience loss from these events when such events affect employees. For example, social support programs and
employer-sponsored health or pension plan costs can be affected by natural or man-made changes. The categorization is
often a matter of perspective. These events may be catastrophic or accidental.

Property Loss Exposures—Property Pure Risk

Property owners face the possibility of both direct and indirect (consequential) losses. If a car is damaged in a collision,
the direct loss is the cost of repairs. If a firm experiences a fire in the warehouse, the direct cost is the cost of rebuilding
and replacing inventory. Consequential or indirect losses are nonphysical losses such as loss of business. For example, a
firm losing its clients because of street closure would be a consequential loss. Such losses include the time and effort
required to arrange for repairs, the loss of use of the car or warehouse while repairs are being made, and the additional
cost of replacement facilities or lost productivity. Property loss exposures are associated with both real property such as
buildings and personal property such as automobiles and the contents of a building. A property is exposed to losses
because of accidents or catastrophes such as floods or hurricanes.

Liability Loss Exposures—Liability Pure Risk

The legal system is designed to mitigate risks and is not intended to create new risks. However, it has the power of
transferring the risk from your shoulders to mine. Under most legal systems, a party can be held responsible for the
financial consequences of causing damage to others. One is exposed to the possibility of liability loss (loss caused by a
third party who is considered at fault) by having to defend against a lawsuit when he or she has in some way hurt other
people. The responsible party may become legally obligated to pay for injury to persons or damage to property. Liability
risk may occur because of catastrophic loss exposure or because of accidental loss exposure. Product liability is an
illustrative example: a firm is responsible for compensating persons injured by supplying a defective product, which
causes damage to an individual or another firm.

Catastrophic Loss Exposure and Fundamental or Systemic Pure Risk

Catastrophic risk is a concentration of strong, positively correlated risk exposures, such as many homes in the same
location. A loss that is catastrophic and includes a large number of exposures in a single location is considered a no
accidental risk. All homes in the path will be damaged or destroyed when a flood occurs. As such the flood impacts a
large number of exposures, and as such, all these exposures are subject to what is called a fundamental risk. Generally
these types of risks are too pervasive to be undertaken by insurers and affect the whole economy as opposed to
accidental risk for an individual. Too many people or properties may be hurt or damaged in one location at once (and the
insurer needs to worry about its own solvency). Hurricanes in Florida and the southern and eastern shores of the United
States, floods in the Midwestern states, earthquakes in the western states, and terrorism attacks are the types of loss
exposures that are associated with fundamental risk. Fundamental risks are generally systemic and nondiversifiable.

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Understand of Risk Burden In our Society

While man-made and natural disasters are the stamps of this decade, another type of man-made disaster marks this
period. Innovative financial products without appropriate underwriting and risk management coupled with greed and lack
of corporate controls brought us to the credit crisis of 2007 and 2008 and the deepest recession in a generation. The
capital market has become an important player in the area of risk management with creative new financial instruments,
such as Catastrophe Bonds and securitized instruments. However, the creativity and innovation also introduced new
risky instruments, such as credit default swaps and mortgage-backed securities. Lack of careful underwriting of
mortgages coupled with lack of understanding of the new creative “insurance” default swaps instruments and the
resulting instability of the two largest remaining bond insurers are at the heart of the current credit crisis.

Feelings Associated with Risk

Early in our lives, while protected by our parents, we enjoy security. But imagine yourself as your parents (if you can)
during the first years of your life. A game called “Risk Balls” was created to illustrate tangibly how we handle and
transfer risk. The balls represent risks, such as dying prematurely, losing a home to fire, or losing one’s ability to earn
an income because of illness or injury. Risk balls bring the abstract and fortuitous (accidental or governed by chance)
nature of risk into a more tangible context. If you held these balls, you would want to dispose of them as soon as you
possibly could. One way to dispose of risks (represented by these risk balls) is by transferring the risk to insurance
companies or other firms that specialize in accepting risks. We will cover the benefits of transferring risk in many
chapters of this text.

Right now, we focus on the risk itself. What do you actually feel when you hold the risk balls? Most likely, your answer
would be, “insecurity and uneasiness.” We associate risks with fears. A person who is risk averse—that is, a “normal
person” who shies away from risk and prefers to have as much security and certainty as possible—would wish to lower
the level of fear. Professionals consider most of us risk averse. We sleep better at night when we can transfer risk to the
capital market. The capital market usually appears to us as an insurance company or the community at large.

As risk-averse individuals, we will often pay in excess of the expected cost just to achieve some certainty about the
future. When we pay an insurance premium, for example, we forgo wealth in exchange for an insurer’s promise to pay
covered losses. Some risk transfer professionals refer to premiums as an exchange of a certain loss (the premium) for
uncertain losses that may cause us to lose sleep. One important aspect of this kind of exchange: premiums are larger
than are expected losses. Those who are willing to pay only the average loss as a premium would be considered risk
neutral. Someone who accepts risk at less than the average loss, perhaps even paying to add risk—such as through
gambling—is a risk seeker.

As we mentioned earlier, in English, people often use the word “risk” to describe a loss. Examples include hurricane risk
or fraud risk. To differentiate between loss and risk, risk management professionals prefer to use the term perils to refer
to “the causes of loss.” If we wish to understand risk, we must first understand the terms “loss” and “perils.” We will use
both terms throughout this text. Both terms represent immediate causes of loss. The environment is filled with perils
such as floods, theft, death, sickness, accidents, fires, tornadoes, and lightning—or even contaminated milk served to
Chinese babies. We include a list of some perils below. Many important risk transfer contracts (such as insurance
contracts) use the word “peril” quite extensively to define inclusions and exclusions within contracts. We will also explain
these definitions in a legal sense later in the textbook to help us determine terms such as “residual risk retained.”

Table 1.4 Types of Perils by Ability to Insure

Natural Perils Human Perils

Generally Insurable Generally Difficult to Insure Generally Insurable Generally Difficult to Insure

Windstorm Flood Theft War

Lightning Earthquake Vandalism Radioactive contamination

Natural combustion Epidemic Hunting accident Civil unrest

Heart attacks Volcanic eruption Negligence Terrorism

Frost Fire and smoke

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Natural Perils Human Perils

Global

E-commerce

Mold

Although professionals have attempted to categorize perils, doing so is difficult. We could talk about natural versus
human perils. Natural perils are those over which people have little control, such as hurricanes, volcanoes, and
lightning. Human perils, then, would include causes of loss that lie within individuals’ control, including suicide,
terrorism, war, theft, defective products, environmental contamination, terrorism, destruction of complex infrastructure,
and electronic security breaches. Though some would include losses caused by the state of the economy as human
perils, many professionals separate these into a third category labeled economic perils. Professionals also consider
employee strikes, arson for profit, and similar situations to be economic perils.

We can also divide perils into insurable and noninsurable perils. Typically, noninsurable perils include those that may be
considered catastrophic to an insurer. Such noninsurable perils may also encourage policyholders to cause loss. Insurers’
problems rest with the security of its financial standing. For example, an insurer may decline to write a policy for perils
that might threaten its own solvency (e.g., nuclear power plant liability) or those perils that might motivate insureds to
cause a loss.

Hazards

Risk professionals refer to hazards as conditions that increase the cause of losses. Hazards may increase the probability
of losses, their frequency, their severity, or both. That is, frequency refers to the number of losses during a specified
period. Severity refers to the average dollar value of a loss per occurrence, respectively. Professionals refer to certain
conditions as being “hazardous.” For example, when summer humidity declines and temperature and wind velocity rise
in heavily forested areas, the likelihood of fire increases. Conditions are such that a forest fire could start very easily and
be difficult to contain. In this example, low humidity increases both loss probability and loss severity. The more
hazardous the conditions, the greater the probability and/or severity of loss. Two kinds of hazards—physical and
intangible—affect the probability and severity of losses.

Physical Hazard

We refer to physical hazards as tangible environmental conditions that affect the frequency and/or severity of loss.
Examples include slippery roads, which often increase the number of auto accidents; poorly lit stairwells, which add to
the likelihood of slips and falls; and old wiring, which may increase the likelihood of a fire.

Physical hazards that affect property include location, construction, and use. Building locations affect their susceptibility
to loss by fire, flood, earthquake, and other perils. A building located near a fire station and a good water supply has a
lower chance that it will suffer a serious loss by fire than if it is in an isolated area with neither water nor firefighting
service. Similarly, a company that has built a backup generator will have lower likelihood of a serious financial loss in the
event of a power loss hazard.

Construction affects both the probability and severity of loss. While no building is fireproof, some construction types are
less susceptible to loss from fire than others. But a building that is susceptible to one peril is not necessarily susceptible
to all. For example, a frame building is more apt to burn than a brick building, but frame buildings may suffer less
damage from an earthquake.

Use or occupancy may also create physical hazards. For example, buildings used to manufacture or store fireworks will
have greater probability of loss by fire than do office buildings. Likewise, buildings used for dry cleaning (which uses
volatile chemicals) will bear a greater physical hazard than do elementary schools. Cars used for business purposes may
be exposed to greater chance of loss than a typical family car since businesses use vehicles more extensively and in
more dangerous settings. Similarly, people heave physical characteristics that affect loss. Some of us have brittle bones,

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weak immune systems, or vitamin deficiencies. Any of these characteristics could increase the probability or severity of
health expenses.

Intangible Hazards

Here we distinguish between physical hazards and intangible hazards—attitudes and nonphysical cultural conditions can
affect loss probabilities and severities of loss. Their existence may lead to physical hazards. Traditionally, authors of
insurance texts categorize these conditions as moral and morale hazards, which are important concepts but do not cover
the full range of nonphysical hazards. Even the distinction between moral and morale hazards is fuzzy.

Moral hazards are hazards that involve behavior that can be construed as negligence or that borders on criminality. They
involve dishonesty on the part of people who take out insurance (called “insureds”). Risk transfer through insurance
invites moral hazard by potentially encouraging those who transfer risks to cause losses intentionally for monetary gain.
Generally, moral hazards exist when a person can gain from the occurrence of a loss. For example, an insured that will
be reimbursed for the cost of a new stereo system following the loss of an old one has an incentive to cause loss. An
insured business that is losing money may have arson as a moral hazard. Such incentives increase loss probabilities; as
the name “moral” implies, moral hazard is a breach of morality (honesty).

Morale hazards, in contrast, do not involve dishonesty. Rather, morale hazards involve attitudes of carelessness and lack
of concern. As such, morale hazards increase the chance a loss will occur or increase the size of losses that do occur.
Poor housekeeping (e.g., allowing trash to accumulate in attics or basements) or careless cigarette smoking are
examples of morale hazards that increase the probability fire losses. Often, such lack of concern occurs because a third
party (such as an insurer) is available to pay for losses. A person or company that knows they are insured for a
particular loss exposure may take less precaution to protect this exposure than otherwise. Nothing dishonest lurks in not
locking your car or in not taking adequate care to reduce losses, so these don’t represent morality breaches. Both
practices, however, increase the probability of loss severity.

Many people unnecessarily and often unconsciously create morale hazards that can affect their health and life
expectancy. Such hazards include excessive use of tobacco, drugs, and other harmful substances; poor eating, sleeping,
and exercise habits; unnecessary exposure to falls, poisoning, electrocution, radiation, venomous stings and bites, and
air pollution; and so forth.

Hazards are critical because our ability to reduce their effects will reduce both overall costs and variability. Hazard
management, therefore, can be a highly effective risk management tool. At this point, many corporations around the
world emphasize disaster control management to reduce the impact of biological or terrorist attacks. Safety inspections
in airports are one example of disaster control management that intensified after September 11. See "Is Airport Security
Worth It to You?" for a discussion of safety in airports.

Diversifiable risk and Nondiversifiable risk

Diversifiable risk is a risk that affects only individuals or small group and not the entire economy. It is a risk that can be
produced or eliminated by diversification. For example, a diversified portfolio of stocks, bonds, and certificates of deposit
(CD’S) is less risky than a portfolio that is 100 percent invested in stocks. Losses on one type of investment, says
stocks, may be offset by gains from bonds and CD’s.

Nondiversifiable is a risk that affects the entire economy or large numbers of persons or group within the economy.
Examples, include rapid inflations, cyclical unemployment, war, hurricane, floods, and earthquakes because large
numbers of individuals or groups are affected. It is a risk that cannot be eliminated or reduced by diversification. risk of
an investment asset (bond, real estate, share/stock, etc.) that cannot be reduced or eliminated by adding that asset to
a diversified investment portfolio. Market or systemic risks are non-diversifiable risks.

Enterprise Risk

Enterprise risk is a term that encompasses all major risks face by a business firm. Such risks include pure risks,
speculative risk, strategic risk, operational risk, and financial risk.

Strategic Risk refers to uncertainty regarding the firm’s financial goals and objectives, for example, if a firm enters a
new line of business, the line may be unprofitable.

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Operational Risk results from the firm’s business operations. For example, a bank that offers online banking services
may incur losses if “hackers” break into the bank’s computer.

Financial Risk refers to the uncertainty of loss because of adverse changes in commodity prices, interest rates, foreign
exchange rates, and the value of money. For example, a food company that agrees to deliver a cereal at a fixed price to
a supermarket chain in six months may lose money if grain prices rise. A bank with a large portfolio of Treasury bonds
may incur losses if interest rates rise. Likewise, an American corporation doing business in Japan may lose money when
Japanese yen are exchanged for American dollars.

Enterprise risk management combines into a single unified treatment program all major risk faced by the firm. As
example earlier, these risk include pure risk, speculative risk, strategic risk, operational risk, and financial risk. By
packaging major risk into a single program, the firm can offset one risk against another. As a result, overall risk can be
reduced.

Major Personal Risks and Commercial Risk

Personal Risks are the risks that directly affect an individual or family. They involve the possibility of the loss or
reduction of earned income, extra expenses, and the depletion of financial assets. Major personal risks that can cause
great economic insecurity include of the following:

1. Premature Death is defined in the death of family head with unfulfilled financial obligations. These obligations
include dependents to support, a mortgage to be paid off, children to educate, and credit cards or installment
loans to be paid. If the surviving family members have insufficient replacement income or past savings to
replace the lost income, they will be exposed to considerable economic insecurity.
2. Insufficient Income during Retirement. The major risk associated with retirement is insufficient income. The
majority of workers in the United States retire before age 65. When they retire, they lose their earned income.
Unless they have sufficient financial assets on which to draw, or have access to other sources of retirement
income, such as Social Security or a private pension,
3. Poor Health is another major personal risk that can cause economic insecurity. The risk of poor health includes
both the payment of catastrophic medical bills and the loss of earned income. Examples major surgery, open
heart operation, kidney, or heart transplant, and others.
4. Unemployment. The risk of unemployment is another major threat of risk to economic security. Unemployment
can result from business cycle downswings, technological and structural changes in the economy, seasonal
factors, imperfections in the labor market, and other causes as well.

Property Risks

Persons owning property are exposed to property risk- the risk of having property damaged or lost from numerous
causes. Homes and other real estate and personal property can be damaged or destroyed because of fire, lightning,
tornado, windstorm, and numerous other causes. There are two major types of loss associated with the destruction
or theft of property, direct loss and indirect or consequential loss.
1. Direct loss is defined as a financial loss that results from the physical damage, destruction, or theft pf property.
For example, if you own a home that is damage by a fire, the physical damage to the home is a direct damage.
2. Indirect or consequential loss. An indirect loss is a financial loss that results indirectly from the occurrence of a
direct physical damage or theft loss. For example, as a result of the fire to your home, you may incur additional
living expenses to maintain your normal standard of living. You may have to rent a motel or apartment while
the home is being repaired. You may have to eat some of all of your meals at local restaurants.

Liability Risks

Liability risks is another important type of pure risk that most persons face. Under our legal system, you can be held
legally liable if you do something that results in bodily injury or property damage to someone else.
Risk to a company arising from the possibility of liability for damages resulting from the purchase, ownership, or use
of a good or service offered by that company. Liability risk can be identified and mitigated through careful product
design and testing, but may also be inherent in the nature of the product to some extent, as in the case
of automobiles or pharmaceutical supplies.

Commercial Risks

Commercial risks refer to potential losses arising from the trading partners or the market. It is important secure that the
trading partners are reliable. In addition, it is important to take into account the trading partner's possible insolvency or
unwillingness to pay. The choice of payment method is of utmost importance. Choosing Trade Finance products and

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 using the delivery clauses will diminish or eliminate many risks related to trading. For example, when a tailored product
is manufactured and paid, we recommend you choose advance payment or documentary credit as the method of
payment.

Examples of how commercial risks can become reality:

 Your trading partner cannot deliver or pay the products/services as agreed.

 Your trading partner does not want to act in accordance with the agreement.
 You have differences in interpreting the trade agreement.

Political risks

It is important for a company to follow the political and economic circumstances and events in its area of operations. In
order words, it has to monitor the country risk. There are many different situations that can involve country risks.
A country's political circumstances may affect the import and export regulations and consequently currency transfers.
Economic circumstances may affect a country's ability to manage its liabilities.

Examples of circumstances where a country risk can become reality.

 Sudden changes in monetary and currency policies or export and import regulations.
 Wars and changes in political and economic alliances.

Risk of damage related to goods

The risks of damage arise from unexpected external factors. For example, goods may disappear or become damaged
during delivery and the insurance policy does not cover this or there is no insurance.
The risks of damage related to goods can be managed by the right choice of payment method, insurance and delivery
terms and conditions.
The collection of delivery terms drawn up by the International Chamber of Commerce (ICC) is commonly used in
international trade agreements.

Burden of risk on society

The presence of risk results in certain undesirable social and economic effects. Risk entail three major burdens on
society.

1. The size of an emergency fund must be increased

2. Society is deprived of certain goods and services
3. Worry and fear are present.

Techniques for Managing Risk

Techniques for managing risk can be classified broadly as either risk control or risk financing.

Risk Control refers to techniques that reduce the frequency or severity of losses.

Risk Financing refers to techniques that provide for the funding of losses. Risk managers typically use a combination of
techniques for treating each loss exposure.

Risk Control

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 1. Avoidance
2. Loss prevention
3. Loss reduction

Risk Financing

1. Retention
2. Noninsurance transfers
3. insurance

TOPIC INDEXES AND KEYWORDS (TIK):

 ________________________
 __________________________

TANGENT ADDITIONAL KEYWORDS (TAK):

 ___________________________________________

EVALUATION (OUTCOME):
Activities

1. List the major types of pure risk that are associated with economic insecurity.
2. Explain the difference between pure risk and speculative risk
3. Explain the historical definition of risk.
4. ASUS Company is an oil and gas company, operating in Southeast Asia. The management decided to expand its
commodity- based business to countries in Asia and Europe. What types of risk may be faced by the company
and what are the techniques that can be used to manage these risks?
5. There are several techniques available for managing risk. For each of the following risks, identify an appropriate
technique, or combination of techniques, that would be appropriate for dealing with the risk.
a. A family head may die prematurely because of a heart attack.
b. An individual’s home may be totally destroyed in a hurricane.
c. A new car may be severely damaged in an auto accidents.
d. A negligent motorist mat be ordered to pay a substantial liability judgment to someone who is injured
in an auto accident.

PRIMARY REFERENCE MATERIAL(S):

Textbook
Risk Management and Insurance by George E. Rejda, 2005 edition, Pearson Addison Wesley, USA

References:
1. An Introduction to Derivatives and Risk Management by Don M. Chance and Robert Brooks
2. www.investopodia.com
3. www.wikipedia.com

INSTRUCTIONAL MATERIALS MADE EASY | GLOBAL NETWORK COLLABORATORS AND CONTRIBUTORS | COMPILED FOR EDUCATIONAL PURPOSES ONLY | UPDATED: 2014.05.15
SECONDARY REFERENCE MATERIAL(S):
 THE World Wide Web

SUBMISSION Instruction:

Deadline : Sunday of Week 04 (Extension: Sunday of Week 05).

e-mail : fm11-9@vem.edu.ph
[COPY FURNISH THE FOLLOWING e-mails: college@vem.edu.ph;
Filename : FM 11-9 - WEEK 02 & 03 – Activity and Output - YOUR NAME.doc
Subject (Re) : FM 11-9 - WEEK 02 & 03 – Activity and Output

Compiled By:

 Instructional Support Network (ISN)

INSTRUCTIONAL MATERIALS MADE EASY | GLOBAL NETWORK COLLABORATORS AND CONTRIBUTORS | COMPILED FOR EDUCATIONAL PURPOSES ONLY | UPDATED: 2014.05.15