Risks

The probability of something happening that might jeopardize achieving the objective.
Systematic risk -> cannot be reduced by diversification. A common risk that is inherent in the
system.
Diversifiable risk -> risk that can be reduced by diversification by combinations of several
distinctive risks.

Types of Risks
Financial Risk: Credit risk (risk of failure of counterparty, supplier to meet their obligation),
market risk (risk of negative consequences due to movement in prices), and liquidity risk
Non Financial Risk: Operational risks (risk of its people, system, processes, or that of external
events), strategic or business risks, application or implementation risks, contagion and related
party risk, competition risk, reputational risks, and so on.
Hazard risk and underwriting risks: Hazards -> fire, natural perils, crime, injury and underwriting
risk refers to mispricing.

Risk Management Framework is the company way of work with regards to identifying,
monitoring, mitigate, assess, and deals with risks.

Risk Management is the approach to manage the impact of risks in order to achieve objectives.

Benefits of Risks Management

1. Managing risk is managements job; not of the shareholders, they only elect management.
2. Managing risk can reduce earnings volatility
3. Managing risk can maximize shareholders value
4. Managing risk promotes job and financial security; one with higher skills in risk management
more likely to retain their jobs, others lose their job and an opportunity to take.

Risks concepts:
1. Exposure; worst that could possibly happen
2. Volatility
3. Probability
4. Severity; damage likely to be suffered
5. Time horizon
6. Correlation
7. Capital
Allocation of economic capital to business units has two important business benefits:
a. Those with more risks need to compensate by generating greater profit
b. Profitability of business units can be compared on consistent risk adjusted basis

Risk Management Process

1. Risk awareness
a. Set the tone from the top; commitments from the board
b. Ask the right question;
i. Key questions that senior management should ask; Return, Immunization
(limits or control to minimize the the downside), System, Knowledge
c. Establish a risk taxonomy
d. Provide training and education
e. Link compensation to risks
2. Risk measurement; risk report should consist of:
a. Losses; those above threshold, total losses relative to revenue and volume, actual
losses vs. expected/budgeted levels
b. Incidents; potential impact, root causes, and business response, emerging trends,
significant patterns
c. Management assessments of potential risks
d. Risk indicators; early warning indicators to allow management to take pre-emptive
action to mitigate potential risks
3. Risk control strategies; ultimate objective is to optimize risk/return. Three fundamental ways
of doing this:
a. Selective growth of the business
i. Discuss key issues at an early stage, develop fair and objective criteria
ii. Allocating corporate resources to business activities with the highest risk
adjusted returns
b. Support profitability; price of any product should reflect the cost of its underlying
risks as well as more traditional costs -> risk adjusted pricing
c. Control downside risks; business is about taking risks, not to eliminate risks but to
control them within an acceptable range.
i. Stop loss limits; amount of losses an institution can incur before triggering
further treatment
ii. Sensitivity limits; amount of potential losses that management does not wish
to exceed -> avoid concentration of risks
4.