Department of Management Sciences, National University of Modern

Languages

Assignment
Submitted by:
Shahraz Mushadi
Roll NO: 31466
Subject: CG
Submitted to: Sir Rao Akmal
Class: MBA (3.5)6th Afternoon
 Chapter # 08
Risk Management
Summary
What is risk?
Most, if not all, business decisions relate to activities to be undertaken in the future.
Inevitably a large portion of these decisions are made without having all the
necessary information in the hand. This gives rise to uncertainty.
Uncertainty exist whenever one doesn’t know for sure what will occur in the future.
Risk is uncertainty that has a potential of a lose. Thus, uncertainty is a necessary
but not a sufficient condition for risk. In certain cases, uncertainty may carry no
possibility of a less at all and hence have no risk.
Why take a risk?
There are necessarily two reasons why people take risk: Inevitably and reward.
Some risks are simple unavoidable; they have to be taken in order to achieve goal
or to perform a task. As for unavoidable risks, they are taken because they offer
rewards.
Causes of Uncertainty:
The origin of Virtually all the risk lies in uncertainty if managers of a company were
able to predict precisely what is going to happen in the future there would be no
uncertainty and no risk.
It is common for companies to complain that it is impossible to predict all the future
events with a great degree of accuracy. It will remain uncertain about it future.
Risk Aversion:
Risk aversion refers to an individual personal company's attitude toward risk. Some
people are willing to take risk and other are not risk adverse people are willing to
pay to reduce their exposure to risk.
Risk Exposure:
If you face a particular type of risk because of your job, the nature of your business,
or your pattern of consumption you are said to have a particular risk exposure.
Risk faced by firms:
Virtually every activity of a company and their exposure to risk. Taking risk is an
essential and Inseparable part of business enterprise. Business risk of a company
are Borne by its stakeholders, shareholders, creditors customers, suppliers,
employees and government.
Company can be classified as operational or pure financial risk:
Operational risk:
These risks are related to operational aspects of the business some of the
operational risks are:
Production and operations risk:
This is the risk that machines will break down, that deliveries of raw material will
not arrive on time, that worker will not show up for work, or that a new technology
will make the forms existing equipment obsolete.
Risk of misappropriation or misuse of company assets:
This include the risk of misappropriation of cash or other assets by employees use
of company properties for non-company purpose is facilitation of records claims and
payments for and benefits to employees for external parties etc.
Price risk of outputs or market risk:
This is the risk that the demand for the bottled uses will unpredictably change
because of an unpredicted shift in consumer preferences.
Price risk of inputs:
This is the risk that the prices of some of the input of the factory will change and
predictably. There may be a crop failure and price of fresh fruit me rise early labor
may become more expensive due to increase in government mandated minimum
wage.
Economic conditions risk:
A change in the general economic conditions of a country or internationally may
have an effect on the business of any company.
Political risk:
A change in government may bring forth changes in governmental policies which
may adversely affect a firm.
Environmental risk:
Poor weather can affect the company in many ways: for Sunny Juices Limited it
could mean higher fruit prices or heavy rain may damage its factory or cause
disruption to production process through labor having difficulty in reaching the
factory.
Project risk:
If Sunny Juices Limited start a new project for example construction of new bottling
plant it may experience a number of risks in Planning and implementing the project.
Delay may take place in construction, arrival of machinery installation,
commissioning etc.
Reputational risk:
if any of the products of Sunny juices Limited are found out to be of poor quality or
some negative to spread about the management of the company among the public
or if the company's labour Union start issuing damaging statement to the press
about the manner that workers are allegedly being mistreated by the company the
reputation of the company may suffer.
Pure financial risk:
These are essentially related to four aspect of financing:
Interest rate risk:
Interest rate risk is the risk that the cost of borrowing main goes up or if a company
has deposited some funds the rote of return on those deposit may go down in the
future.
Forex risk:
It arises when a company undertakes International transaction. If a firm import a
lot of goods and gets credit for such import it faces the risk.
Market value of securities risk:
If a company hold investments in the form of tradable financial instruments like
shares Bond etc. the value of these assets will depend on the prevailing market price
which he keeps fluctuating from time to time.
Credit Risk:
If a company sells goods and on credit it runs the risk of losing a part of its
receivables through bad debt. This is referred to as credit risk and is faced by most
companies engaged in manufacturing and for sale of non essential goods.
Who bears these risks?
The shareholders of Sunny juices Limited are not the only people who bare the risk
of business. The company's managers and its other employees are also affected by
some of these risk.
If the probability is low or if the production technology changes some of them may
lost their jobs or be forced to take a cut in pay.
Managing risk in a company:
The process of formulating the cost-benefit trade-offs of risk reduction and deciding
on the course of action to take to reduce or eliminate risk is called risk management.
Responsibility of managing the risks:
The company’s board of director is ultimately responsible for managing the risk
faced by the company because of basic duty to protect the company's Assets and
risk management is very much a governance issue.
The risk management process:
Risk management process is a systematic attempt to analyze and deal with risk the
process can be broken down into 5 steps:
1. Risk Identification
2. Risk Assessment
3. Selection of risk management techniques
 4. Implementation
5. Review
Risk Identification:
Before a company can make any plan or policy about how to handle the risks it faces,
it must be fully aware of all the risks that it is exposed to.
Risk assessment:
Risk assessment will involve finding answers to the following three questions:
• How likely is it for any of these risk to actually happen?
• What is the maximum possible financial loss that you will suffer is it each of
the listed situation?
• Can the company afford to assume that risk is itself if not what would be the
cost of eliminating or transferring this risk to someone else?
Selection of risk management techniques to be used:
The next step is to decide what step to taken to eliminate or reduce the impact of
risk.
Their four basic techniques available for reducing risk namely:
• risk avoidance
• Loss prevention and control
• risk retention and
• Risk transfer
Regular review of risk situation:
Risk management is a dynamic feedback process in which decisions are periodically
reviewed and revised. As this time passes and circumstances change, new exposures
may arise and severity of risks may become more readily available, and techniques
for managing them may become less costly.
Implementing the risk management plan:
Following a decision about how to handle the risks identified, one must implement
the technique selected. The underlying principle in this step of risk management
process Is to minimize the cost of implementation.
Risk transfer techniques:
1. Hedging:
One is sold to hedge a risk when the action taken to reduce one’s exposure to a loss
also causes one to give up the possibility of gain.
2. Buying options:
An option gives the buyer a right to buy an item at predetermined price on a
predetermined date. This is however a right not an obligation.
Types of options:
Two types:
• Put options
• Call options
Put options:
A put option is an option to sell at some future date an item at the price agreed now.
Call option:
A call option is an option to buy at some future date an item at the price agreed
now.
There is fundamental difference between hedging and options. When you hedge
you eliminate the risk of loss by giving up for the potential of gain. When you buy
an option you pay a fee to eliminate the risk of loss and eliminate the potential for
gain.
Insuring or Insurance:
Insuring means paying a premium to avoid losses. By buying insurance, you
substitute a sure loss for the possibility of much larger loss if you don’t insure. One
important fact to remember about insurance is that by getting an insurance policy
an insured simply covers himself against a loss he doesn’t benefit or profit from it.
Diversifying:
Diversifying means holding smaller amount of many risky assets instead of
concentrating all of your investment in only one asset. Diversification limits your
exposure to risk of any single asset.
Diversification can take many forms. It can be claimed out by individual inventor
directly in the market, or by the firm or by the financial intermediary.
Managing pure financial risk
Means of handling interest risk:
The interest rate can go up and go down during the tenure of the loan. If they go
down, then his interest cost will also come down. But is they go up the borrower will
have to suffer the additional interest cost.
Means of handling forex risk:
A company is exposed to forex risk if it’s financial liabilities or assets dominated in
a currency other than the currency of its country. The following methods are
available to Pakistani importers to protect themselves from forex risk:
• Forward buying of foreign exchange at a pre-set rate
• Buy an option to buy or cell dollar at a rate set now
• Currency swap
Financial derivatives:
According to financial reporting standard 13 derivative is defined as a financial
instrument that derives it’s value from the price or rate of some underlying items
like a share, bond, commodity, currency, interest rate, exchange rate etc.
Means of handling stock market risk:
If a company holds shares in OR bonds of another company, the change in market
price of such investments can have an impact on balance sheet. Risk associated in
financial assets can be classified as:
1. Systematic risk
2. Unsystematic risk
Systematic risk:
It is a risk that is faced by entire industry or economy as a whole. This risk cannot
be diversified as all the units operating in a particular industry are effected by it.
Unsystematic risk:
It is a risk that is faced by particular company but not by other units operating in
the same industry or economy.
The simplest means of handling stock market risk is to have a well diversified
portfolio.
Means of handling default (credit) risk:
The following options maybe considered to minimize credit risk:
• Do not offer any credit facilities to all
• Get credit insurance
• Ask the customers to open local letters of credit
• Have a well designed and comprehensive credit policy which includes:

a. Very strong debtors vetting process before agreeing to extend credit

b. A comprehensive credit record and follow up process
c. Offering cash discount for prompt settlements of dues and finally
d. A strong legal recourse for recovery of overdue balances.
Steps in managing financial risk:
1. Risk Identification
2. Risk Assessment
3. Exposure of risk management techniques
4. Making formal arrangements for implementing the risk management
techniques
Institutions for risk management:
Following are the institutions that assist in risk management:
• Insurance companies
• Stock exchanges
• Specialist traders in forward contact and options
• Mutual funds
 • Financial institutions offering guarantee, letter of credit, underwriting of
shares, and bond issues and similar facilities.
Disaster recovery:
Disaster happen some are like earthquake and tsunami. Companies must prepare
for disasters and the life after disasters. The directors must ensure that a formal
disaster recovery plan is in place which helps the company resume its operations
quickly and efficiently.
A very important aspect of disaster recovery is the security of financial data.
Common lapses in the risk management:
Most common mistakes relating to risk management are:
1. Over-reliance on historical data
2. Over-looking knowable risks
3. Over-looking concealed risk
4. Falling to communicate
5. Inadequate review
Report by board of risk management:
This report covers the following point:
• It lists the significant risk faced by the company and how they are being
identified, assessed and managed.
• It reports on the effectiveness of the system put in place to manage these
risks and
• It lists the actions being taken to remedy any significant failing or weaknesses
may have already been detected.
• It also comments on the need, if any for greater monitoring of procedures.
The role of government in risk management:
Government is playing an important role for the public at large either by preventing
them or redistributing them. People often rely on government to provide protection
and financial relief from natural disasters and various human caused hazards
including war and pollution of the environment.