KOLEJ UNIVERSITI TUNKUABDUL RAHMAN

FACULTY OF ACCOUNTANCY, FINANCE AND BUSINESS

SEMESTER DECEMBER 2017/2018
BBMF 3073 RISK MANAGEMENT
TUTORIAL 1 (WEEK 2)

1. Define risk. In your definition, state the relationship between risk and uncertainty.

Risk is defined as an uncertain event or set of events that, should it occur, will influence the
achievement of objectives. A risk is measured by the combination of the probability of a
perceived threat or opportunity occurring and the magnitude of its impact on objectives.

In my definition, it is the probability of winning or losing something worthy. While uncertainty

implies a situation where the future events are not known. Risk can be measured
while uncertainty cannot be measured. Besides that, risk can be controlled while
uncertainty is uncontrollable. Moreover, risk can be minimized while uncertainty cannot be
minimized.

2. Risk may be sub-classified in several ways. List the three principal ways in which risk may be
categorized, and explain the distinguishing characteristics of each class.

- Fundamental risks (Basic risks). Those affect everybody in society such as haze.
Fundamental risk of Apple : Technology advancement risk when their competitor
Samsung has a new product.
- Particular risks. Those risks over which individuals can control such as risk attached to
smoking.
- Pure risks. Those whose only possible outcome is harmful such as risk of losing data
caused by fire.

3. The distinction between “pure risk” and “speculative risk” is important because only pure
risks are normally insurable. Why is the distinction between “fundamental risk” and “particular
risk” important?

- Fundamental risks and particular risks known as specific risk. An example of the
fundamental risk is market risk. This type of risk is known in finance as the systematic
risk or non-diversifiable risk. The clear distinction between these two risks will help
portfolio managers in investment management to achieve the best level of efficiency
through diversification.

Fundamental risk for people with obesity is heart attack.

4. List the four types of pure risk facing an individual or an organization and give an example of
each.

- Personal risks. These consist of the possibility of loss of income or assets as a result of
the loss of the ability to earn income. For example, sickness and disability and
unemployment.

- Property risk. People who own property will face property risk simply because such
possession can be destroyed or stolen. Property risks may involve two types of losses
which are the loss of the property and loss use of the property resulting in lost income or
additional expenses.

- Liability risk. The basic peril in the liability risk is the unintentional injury of other
persons or damage to their property through negligence or carelessness. However,
liability may also result from intentional injuries or damage.

- Risk arising from failure of others, When another person agrees to perform a service
for you, he or she undertakes an obligation that you hope will be met. When the person’s
failure to meet this obligation would result in your financial loss, risk exists. Examples of
eisk in this category would include failure of a contractor to complete a construction
project as scheduled, or failure of debtors to make payments as expected. With the
development of the Internet, the rapid evolution of e-commerce by big business, a variety
of new risks relating to the failure of others have emerged.

5. Briefly distinguish among the three categories into which hazards may be divided and give an
example of each.

- Physical hazards consist of those physical properties that increase the chance of loss
from various perils. Exp: stress

- Moral hazard refers to the increase in the probability of loss that results from dishonest
tendencies in the character of the insured person. Exp: smoking

- Morale hazards not to be confused with moral hazard, acts to increase losses where
insurance exists, not necessarily because of dishonesty but will be paid by insurance.
Exp: A person buys insurance for his house, and morale hazards arise when the house on
fires, and the person no longer cares about it.
6. Discuss the key risks that a financial institution faces. ( 5 points)

Some of the key risks for financial institutions include Credit Risk. It occurs when
borrowers or counterparties fail to pay the creditors on time. For example: Borrowers
default on a principal or interest payment of a loan. Resulting in the financial institution
not obtaining the required funds and hence having tight liquidity, increasing liquidity risk
and jeopardizing the financial institution’s reputation.

Liquidity Risk is the risk of loss due to a mismatch between cash inflow and outflow due
to the poor cash management such as the payables are paid faster than collection from
receivables. Resulting the financial institution to be unable to meet its obligations.

A financial institution may have their goodwill impacted as a result of the adverse
consequences of another risk, this is known as Reputation risk. In this case, the credit
risk that increased liquidity risk has brought the financial institution reputation risk.

Market Risk is due to the unpredictability of equity markets, interest rates, credit spreads
and commodity prices. Hence, if banks are heavily involved in investing in capital
markets or sales and trading, they are most likely to be exposed to market risk when there
is an adverse movement in the market. The overall decline in the market may cause the
organization to cease operation.

Financial Risk may also occur due to lack of leverage in a financial institution which
may include currency exchange risk.

7. Discuss three (3) benefits of risk management to an organization.

Effective risk management is likely to improve an organization’s performance for example :
- fewer sudden shocks and unwelcome surprises
anticipate the possibility of the problem and get prepared to face it with the existing
resources.
- more efficient use of resources
efficiently allocate the resources before problem arise which lead to act with confusion
- reduced waste
since the resources are efficiently allocated and used, there will be reduce of waste.