Chapter 12 strategic management

8/10/2019 Chapter 12 strategic management

1/28


2/28

Oxford University Press 2011

Chapter 12Risk Management:

Perspectives and Issues


3/28


Risk Management: Perspectives

and Issues

Behold the turtle, he makes progress only whenhe sticks his neck out.

Bruce Levin


4/28


Learn ing Object ives

To define uncertainty and risk and delineate their

impact on strategy

To identify the different types of risk and classify them

To develop the concept of risk assessment and

various methods of measurement

To discuss the various mathematical models of risk

management

To identify various risk management techniques


5/28


UNCERTAINTY AND RISK

Uncertainty

Whenever some of the parameters are not clearly defined or the

probabilities are not known and they are not measurable, the

event becomes an uncertainty

Risk

Risk can be defined as the function of three variables namely:

Probability of a threat

Probability of vulnerabilities and

Probability of a potential impact


6/28


CLASSIFICATION OF RISK

PHYSICAL RISK

Accidents:The primary cause of mortality from accidents causedby consumption of alcohol or drugs, tiredness, and disregard for

safety precautions such as usage of helmets, and seat belts

Health risks: These arise from biological factors such as exposure

to radiation, bacteria, viruses, fungi, and other micro-organisms Chemical risks: Effluents from chemical industries, leather

tanneries, textile dyeing, and nuclear power plants

Bioterrorism:biological agents used by the terrorists have become

potential threats to human life and health

Food adulteration: Improper storage of food products leads to

their deterioration and use of pesticides and insecticides in farming

poses potential health risks


7/28 Oxford University Press 2011

COUNTRY RISK

Political risk: political changes in a country resulting in instability of

a government

Legislative risk: fall out of the political risk change in governments

Micro risk: political actions in a host country which can affect

selectively certain foreign operations

Economic risk: emanates from the Economic and Industrial Policy

pursued by the government of the country

Sovereign risk: sovereignty is measured by the credit rating of the

country

Counterparty risk or default risk: business transactions which aforeign investor has to undertake with indigenous businessman

Currency risk: stability of the currency of a country and its parity

with the currencies of other countries



BUSINESS RISK

Systematic risk:

This risk which is part of business, arises due to factors that

affect the entire market such as changes in investment policy,

taxation policy, socio-economic parameters, global security

threats, etc

Unsystematic risk

This risk is specific to an individual, firm or a company and as

such fuller comprehension can lead to substantial reduction of

this risk



FINANCIAL RISK

Credit risk: This risk is defined as the likelihood that a borrower

will fail to meet his commitments in accordance with agreed terms

Liquidity risk: This risk can relate to asset liquidity as well as

funding liquidity

Market risk: This risk deals with the portfolio of a companysinvestments. Four important market risk factors which affect

valuation are Stock prices, Interest rates, Foreign exchange rates

,Commodity prices

Operation risk: This risk is influenced by the availability of raw

materials, consistency of output, transport and movement issues,

and labour-related issues



ASSESSING AND MEASURING RISK

Sensitivity Analysis

It is the one most adopted by analysts, both for short-term and

long-term purpose

In a budgetary exercise, which is essentially a short-term one,

capacity utilization, price demand, etc., are taken separately as

well as together to measure the impact of the variation in the

parameter on profits/performance

In the long-term, sensitivity analysis identifies/focuses on suchparameters that are sensitive to the passage of time, such as

assumptions relating to statutory decisions, technological

obsolescence, and product life cycles



Scenario Analysis

Measure the impact of risks on strategic performance

More qualitative than quantitative

creating possible scenarios over the time span of strategy

formulation and implementation delineating the impact of thespecific parameters selected for analysis.

For instance, government decisions are known to impact

corporate strategic performance in the form of availability of tax

holidays, stimulus packages, duties and levies, etc. and these

are identified as risks.


12/28



Monte Carlo Simulation

This model provides a decision maker with a range of possible

results and probabilities that they will happen for any choice ofaction

The essence of a Monte Carlo simulation is that values are

sampled at random from the input probability distributions

Certainty Equivalent

A risk-averse individual or company always wants to gauge the

degree of risk and compute a return correspondingly as a

compensation for the additional risk

Higher the risk, the certainty coefficient is lower.

For instance, certainty equivalent coefficient is higher for a

replacement investment as against a new product investment



Risk Adjusted Discount Rate Method

rp = rf + n + dp

where

rp = Risk adjusted discount rate for project p

rf = Risk free rate of interest

n = Premium for normal riskdp = Premium for additional risk

Risk Adjusted Return on Capital

RAROC = Expected return/Economic capital or

RAROC = Expected return/Value at risk



Asset Liability Management Model

Matching of assets and liabilities to generate a cautious

investment portfolio.

The purpose of this model is to optimize risk-adjusted returns to

the shareholders over a long run.

Two approaches for matching assets and liabilities are as follows Durat ion: This is defined as a measure of price sensitivity in

relation to interest rates. It refers to the weighted average

maturity where the weights are applied in terms of present value



Contd.. Convexity

This is defined as the change in duration corresponding to

changes in yield as follows:

where

Di = Change in yield (in decimals), P0 = Initial price

P+ = Price if yields increase by Di, P- = Price if yields decline by Di

Combining convexity and duration is a good approach to examining

the influence on change in yield on the market values of assets

and liabilities



Beta Analysis

Beta can be used to determine the actual riskiness of the stock

Beta = Co-variance(i, m)/Variance(m)

Where i = i th stock

m = market movements

Probability risk assessment (PRA):

In this method, risk is identified by two factors, namely, the severity

of adverse consequences that are possible and the probability of

such an occurrence of each consequence



Value at Risk (VaR)

VaR is one of the popular methods of measuring financial risks.

There are different types of VaRlong-term VaR, marginal VaR,

factor VaR, and shock VaR

VaR is defined as the threshold value such that the probability of a

portfolio making a market to a market loss over a specific time

horizon exceeds this value

VaR essentially identifies the boundary between normal days and

extreme occurrences

VaR applications - financial risk management, risk measurement,

control and reporting, calculating regulatory capital.



Black Scholes Model

This model is a mathematical representation of financialmarkets and derivative investment instrument

This is based on partial differential equations, the solution of

which is applied in pricing options.

The assumptions include the price of the stock, risk free interest

rate, drift rate, volatility of the asset, time frame, value of the

portfolio, and accumulated profit or loss on the basis of a

particular hedging strategy.

Standard normal cumulative distribution function and a

standard normal probability density function are also included


20/28


Hazard and Operability Study(HAZOP)

The HAZOP study is a systematic and structured application

to examine a projected or current process or operations inorder to identify and evaluate areas that may prove to be a

risk to employees or equipment

Worksheets on HAZOP include the following

Reference number , Guide word , Deviation, Possible causes,

Consequences, Safeguards, Recommendations regarding

action to be taken, Follow-up

Procedurally this study applies to

all sequences of operations, identification of human errors and

failures of technical systems, and establishing boundary

conditions


21/28


22/28


Risk avoidance

This principle is based on the possibility of totally

avoiding a risk that has been identified

This can be done by not performing an activity that

potentially spells risk such as the purchase of a

property or business that is prone to litigations

If a particular business activity in the company

involves high risk, this business activity can be closeddown or phased out


23/28


Risk reduction

Risk reduction or optimization aims at reduction in the severity

of laws or the probability that laws may not be passed

Risk reduction can be termed as mitigation that would include all

measures taken to reduce the effect of the hazard

It includes steps to mitigate physical, economic, and socialvulnerability

Outsourcing can be considered an act of risk reduction if the

vendor has the expertise and a higher capability in mitigating risk.

For example, demolition of an old, risky, high-rise building could be

outsourced to an expert vendor who could implode the building

without causing any damage to the environment or people


24/28


Risk retention

Risk retention as an exercise and a strategy is attempted

mainly in the case of operational risk in business

This denotes acceptance of the loss or benefit arising out of

a risk when it takes place

In short, it is also termed as self insurance

This method is useful

-When the probability of occurrence is very low

-a reserve built within the system over a period can take

care of such losses arising out of risk retention


25/28


Combination of risks

Where an individual, a firm, an organization, or a company

faces more than one risk, it becomes necessary tounderstand these different risks and their relationships

It becomes necessary to assess the overall risk caused by

such risks and the possibility of reduction, if combined

EX. Portfolio management

This is particularly important where the cost of mitigation or

transfer of individual risks put together is far greater than the

cost of transferring or mitigating

When risks in projects are considered for combination, three

types of risk scores are computed viz Hazard scores,

Exposure scores , Combined scores


26/28


Sharing of risk

This term denotes sharing of risk with another party, and the

loss or benefit arising from a risk

For instance an insurance company or any third party, who is

an expert in handling risk, compensates the risk bearer for the

loss that arose from a risk that occurred.

sharing of risk is also termed as risk transfer

The risk bearer has to own an insurable interest that can be

transferred to an insurer for a consideration known aspremium

Compensation, too, is set at a particular value indicated in the

policy.


27/28


Hedging risk Risk arising from price fluctuations, fluctuation in foreign

exchange currency parities, etc. are covered by forward

contracts with special agencies such as financial institutions

an effort to offset the risk of price fluctuations in the opposite

direction in another market to reduce the unwanted risk

There are various special vehicles available in finance

Forward contracts, swaps, options, and many types of over-the-

counter and derivative products, as well as of futurescontracts


28/28

O f d U i it P 2011

More Questions1. How does risk modeling help risk assessment? In addition,

identify a particular risk and apply any one of the techniquesfor assessment

2. Identify a conglomerate that has many diversified activities

out of which a few are risk-prone. How can the risks be

phased out? Prepare a report

3. Visit a service company near your institute and identify

operational risks and the reason for retention of operational

risk

4. Cite an example of a company and work out an assignment

by identifying various risks that can be transferred.

Date post:	02-Jun-2018
Category:	Documents
Upload:	sagarfunk
View:	222 times
Download:	0 times

Chapter 12 strategic management

Documents