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W1 Summary - Intro to Risk Management - Coggle Diagram
W1 Summary - Intro to Risk Management
? What is Risk
Risk = “Unexpected Outcome”
|| >> The possibility of an outcome differ from one’s Expectation
? Components of Risk
Probability
of the Variation to happen; Eg. During Normal vs Difficult times (due to pandemic, war, etc...)
Impact Magnitude
of the Variation
(!) How will Bluechips vs Pennies stock behave ?
Mostly similar Probability... but different Magnitude, given the same market/ country/ social conditions.
? Types of Risks facing business
Non-financial Risk
– arise from day-to-day core business activites, internal management of the company itself.
Financial Risk
– external environment facing company’s cash position
R1. Financial Risks
(i) Definition of Financial market risks
|| >> …are The risks coming from fluctuation of the world’s major financial markets
Changes in commodity prices can affect the ability of the business to make profit (e.g raising products’ prices, affecting the company’s ability to buy low and sell high)
Fluctuations in a currency price can affect the value of a company’s revenues/expenses (import/export businesses) or change companies' assets (in case of multi-national companies)
Changing interest rates potentially result in liquidity risk (the ability to pay interest when interest rate rises, or when sales slow down)
--> Likely to risk companies that borrow alot
(i) Types of Financial Market Risks)
(ii) Credit risk
(!) Mitigation?
Maintaining appropriate capital structure (debt-equity proportion)
Strict compliance with the payment and other terms on the debt contracts to retain good credit score
Keep reasonable capital structure (Debt / Equity)
|| >> Banks are reluctant to lend to companies with low or reduced Credit Rating. Those poor credit companies, if allowed to borrowed, will likely be charged with higher interest rates
(iii) Liquidity risk
|| >> The probability that companies go bankrupt because it lacks capital to stay liquid (e.g lack of cash to pay for the bills and liabilities)
Mitigation?
Closely control working capital and liquidity ratios (eg. Interest Coverage ratio
Maintain good credit score to be able to borrow short-term when needed in order to fulfil payments when they come due.
(iv) Counterparty risk
|| >> This is caused by business partners running into trouble, or going bankrupt, causing losses of major supply/sales contracts
Mitigation?
Carefully select vendors or business partners to trade with.
R2. Non-financial risks
Operational risks
|| >> Resulted from inadequate management of day-to-day business activities (or internal control of the business).
Mitigation:
Good organization structure (clear division of tasks and responsibilities)
Proper leadership
Strategic risks
|| >> Resulted from bad investment decision (investingin bad project, or not investing in good, turning around opportunity)
Mitigation:
Invest in research and development
Leaders need to be sensitive to changes in the market/business
Reputation risks
|| >> This is where reputation of a business is heavily affected by factors such as:
senior managers committing illegal acts
company causing damage to the environment or the local
Legal or regulatory risks
Mitigation:
Respect environmental laws
Transparent corporate governance, remuneration policies etc…
|| >> This risk comes from changes in the government policies and laws. Some firms will be directly and heavily affected (e.g farming business affected by the government’s subsidy. Motor companies affected by the tax law).
R3. Some other risks (cont.)
Information risk:
e.g lack of update information about (existing and potential), competitors, new technology, new market trend etc. leading to inappropriate strategy (which often leads strategic risk)
Economic risk: economic cyclicity (Recession / Expansion)
War/terrorism: rarely happening but possible
Approaches to managing risks
1) Passive Risk Management
“Do nothing”
Adopted when exposure is small, or costs outweigh benefits
Could mean the company is unaware of the exposures it has.
This could be considered as not risk management at all.
“Cover everything”
All exposures that can be identified are fully covered
Costly and prevent the company from enjoying favorable movements in the market.
2) Active risk management
Consider cost/benefits.
Only cover significant risks based on companies’ analysis