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Business Finance Las Week 3 and 4
Business Finance Las Week 3 and 4
BUSINESS FINANCE
Second Quarter
Week 3 and 4
Brown and Reilly (2014) identified the major sources of risks as follows:
1. Business risk
2. Financial risk
3. Liquidity risk
4. Exchange rate risk
5. Country risk
Business risk is related to the nature of the company’s products and operating strategy.
Companies with stable sources of sales and earnings have relatively low business risk.
Financial risk refers to the risk created by the choice of capital structure—the financing
mix of the issuing company. A company usually funds its operation through debt and equity
financing. As the debt portion increases, financial risk increases.
Liquidity risk is the uncertainty that an investment can be converted to cash at a known
price. The existence of exchange facilities eases in liquidating an investment. If there is no
ready market for the investment, it is considered illiquid and a higher liquidity premium is
required by investors. The presence of many ready buyers and sellers reduces liquidity risk.
Exchange rate risk exists if the investment is denominated in another currency different
from that of the local currency of the investor. An additional uncertainty exists if the investor
needs to liquidate the foreign currency-denominated investment and convert it to Philippine
peso, for example.
Source:https://www.clearrisk.com/risk-management-blog/bid/47395/the-risk-management-
process-in-5-steps
1. Identify Risks. The four main risk categories of risk are hazard risks, such as fires or
injuries; operational risks, including turnover and supplier failure; financial risks, such
as economic recession; and strategic risks, which include new competitors and brand
reputation. Being able to identify what types of risk you have is vital to the risk
management process.
An organization can identify their risks through experience and internal history,
consulting with industry professionals, and external research. They may also try
interviews or group brainstorming.
2. Measure Risk. A risk map is a visual tool that details which risks are frequent and
which are severe (and thus require the most resources). This will help you identify
which are very unlikely or would have low impact, and which are very likely and would
have a significant impact.
Knowing the frequency and severity of your risks will show you where to spend
your time and money, and allow your team to prioritize their resources.
3. Examine Solutions. Organizations usually have the options to accept, avoid, control,
or transfer a risk.
Accepting the risk means deciding that some risks are inherent in doing business
and that the benefits of an activity outweigh the potential risks.
Risk control involves prevention (reducing the likelihood that the risk will
occur) or mitigation, which is reducing the impact it will have if it does occur.
4. Implement Solution. Once all reasonable potential solutions are listed, pick the one that
is most likely to achieve desired outcomes.
Find the needed resources, such as personnel and funding, and get the necessary
buy-in. Senior management will likely have to approve the plan, and team m embers
will have to be informed and trained if necessary.
5. Monitor Result. Risk management is a process, not a project that can be “finished” and
then forgotten about. The organization, its environment, and its risks are constantly
changing, so the process should be consistently revisited.
Determine whether the initiatives are effective and whether changes or updates
are required. Sometimes, the team may have to start over with a new process if the
implemented strategy is not effective.
A basic risk measure for a single asset is the variance and standard deviation (square root
of the variance) of returns. The variance () is computed as follows:
n
=
[Rt – Rmean]2
t=n n
Where:
Rt = Return for a Particular Period
Rmean = Average return
n = Number of Periods
Stock A
2011 13.25%
2012 16.25%
2013 13.80%
2014 20.70%
2015 11.20%
Sum = 0.00529870
5. Divide by the number of periods.
Variance = 0.00529870 / 5 years = 0.00105974
The standard deviation is equal to the square root of the variance:
= he standard deviation of the returns of Stock A is equal to 3.26%. The
greater the standard deviation of the returns, the greater is the risk of the single a sset.
Risk-Return Measure
Assets should be compared based on both risk and return. The coefficient of variation
is a simple risk-return measure to compare various assets. It is computed by dividing the
standard deviation of returns by the mean return.
LEARNING COMPETENCY
Measure and list ways to minimize or reduce investment risks in simple case problems, Quarter
2, Week 1-2) ABM_BF12-IVm-n-25
Exercise 2. Directions: Write A if the statement is correct, write B if the statement is incorrect.
Write your answer in the space provided for you.
1. The lower the standard deviation is, the lower is the risk of the single asset
2. Volatility considered systematic investment and non-systematic investment.
3. Return on investment should be considered in analyzing risk.
4. Volatility is often calculated using variance and standard deviation
5. The standard deviation is equal to the square root of the variance.
6. Assets should be compared based on both risk and return.
7. Liquidity risk exists if the investment is denominated in another currency different
from that of the local currency of the investor.
8. Companies with stable sources of sales and earnings have relatively low business risk.
9. A company usually funds its operation through debt and equity financing.
10. Risk can be defined as the uncertainty of returns.
Exercise 1
1. C
2. C
3. D
4. A
5. C
6. C
7. C
8. C
9. B
10. D
Exercise 2
1. A
2. A
3. A
4. A
5. A
6. A
7. B
8. A
9. A
10. A