Risk CH1

• Risk and risk management

  are critical to good business and investing.
• Taking risk

  an active choice by boards and management, investment managers, and individuals
• Risk exposure

  the extent to which an organization’s value may be affected through sensitivity to underlying risks.
• Risk Management

  a process that defines risk tolerance and measures, monitors, and modifies risks to be in line with that tolerance
• Risk management framework

  is the infrastructure, processes, and analytics needed to support effective risk management.
• Risk management framework includes:

  Risk governance

  Risk identification and measurement

  Risk infrastructure

  Risk policies and processes

  Risk mitigation and management

  Communication

  Strategic risk analysis and integration
• Risk governance

  the top-level foundation for risk qualitative assessment of all potential sources of risk and the organization’s risk exposures.
• Risk infrastructure

  comprises the resources and systems required to track and assess the organization’s risk profile.
• Risk policies and processes

  management’s complement to risk governance at the operating level
• Risk mitigation and management the active monitoring and adjusting or risk exposures, integrating all the other factors of the risk management framework.
• Communication

  includes risk reporting and active feedback loops so that the risk process improves decision making
• Strategic risk and integration

  using these risk tools to rigorously sort out the factors that are not adding value
• Employing a risk management committee, along with a chief risk officer (CRO)

  are hallmarks of a strong risk governance framework.
• Governance and the entire risk process

  should take an enterprise risk management perspective to ensure that the value of the entire enterprise is maximize
• Risk tolerance

  a key element of good risk governance, delineates which risk are acceptable, unacceptable, and how much risk the organization can be exposed to
• Risk budgeting

  any means of allocating investments or assets by their risk characteristics.
• Financial risks

  arises from activity in the financial market.
• Financial risks consist of:

  Market risk

  Credit risk

  Liquidity risk
• Market risk

  arises from movements in stock prices, interest rates, exchange rates, and commodity prices.
• Credit risk

  is the risk that a counterparty will not pay an amount owed.
• Liquidity risk

  risk that is a result of degradation in market conditions or the lack of market participants, one will be unable to sell an asset without lowering the price to less than the fundamental value.
• Non-financial risks

  arises from actions within an organization or from external origins, such as the environment, the community, regulators, politicians, suppliers, and customers.
• Non-financial risks consist of:

  Settlement risk

  Legal risk

  Regulatory risk

  Accounting risk

  Tax risk

  Model risk

  Tail risk

  Operational risk
• Operational risk

  risk that arises either from within the operations of an organization or from external events that are beyond the control of the organization but affect its operations (employees, the weather and natural disasters, vulnerabilities of IT systems, or terrorism)
• Solvency risk

  risk that the organization does not survive or succeed because it runs out of cash to meet its financial obligations.
• Risks are not necessarily independent

  because many risks arise as a result of other risks; risk interactions can be extremely non-linear and harmful.
• Risk drivers

  are the fundamental global and domestic macroeconomic and industry factors that create risk.
• Common measures of risk

  includes standard deviation or volatility; asset-specific measures, such as beta or duration: derivative measures, such as delta, gamma, vega, and rho; and tail measures such as value at risk, CVaR and expected loss given default.
• Risk can be modified by

  1. prevention and avoidance
  2. risk transfer (insurance)
  3. risk shifting (derivatives).
• Risk can be mitigated internally through

  self-insurance or diversification.
• Key factors in managing businesses and investments:

  Proper identification and measurement of risk

  Keeping risks aligned with the goals of the enterprise
• Portfolio managers

  need to be familiar with risk management not only to improve the portfolio's risk-return outcome, but also because of two other ways in which they use risk management at an enterprise level
• Portfolio managers

  need to evaluate the companies' risks and how those companies are addressing them.
• Risk

  measures the probability and severity of loss or injury.
• Risk Assessment Policy

  the degree of risk posed by a specified exposure or activity should be separated, to the extent feasible
• Risk Assessment Policy

  the degree of risk posed by a specified exposure or activity should be separated, to the extent feasible
• Goal of risk assessment

  is to describe the possible health consequences of changes in human exposure to a hazardous substance; the need for accuracy implies that the best available scientific knowledge, supplemented as necessary by assumptions that are consistent with science, will be applied.
• Conservatism

  the appropriate response to uncertain environmental risks is to balance the social costs of false negatives (substances or activities incorrectly thought to be safe) with the costs of false positives (those incorrectly believed to be hazardous).
• The application of this approach requires pieces of information:

  1. the cost of a false negative
  2. the cost of a false positive
  3. the probability of each
• Risk Transfers

  often a regulatory action that reduces one risk will increase another (when the particular benefit obtained is considered essential but the method for achieving the benefit carries risks).