Introduction To Risk Management: Topic 1

Introduction to Risk Management
Topic 1
May 12, 2008 Dilarang memperbanyak semua ataupun sebagian dari material tsb tanpa seijin SBM-ITBI® 1
Agenda
1. Risk?
2. What is risk management?
3. Types of risks
4. Levels of risks
5. Methods and TOOLS of risks
6. EVALUATE AND MINIMIZE RISKS
FIRM VALUE
1. Risk
“The threat or possibility that an action or
event will adversely or beneficially effect
an organization’s ability to achieve its
objectives.”
Need to quantify risk and organize
structure to manage.
Two terms of Risk
Risk event is defined as the occurrence
of an event that creates the potential for
loss (a bad outcome).
Risk loss refers to the losses incurred as
a direct or indirect consequence of the risk
event. Such losses can be either financial
or non-financial
Introduction > Risk example
> Risk factors
 Shark
 Act of surfing
Introduction > Risk example
> Risk factors
> Ladder construct
> Driver
Introduction > Trust example
> Trust
>Assured reliance on the
character, ability, strength or truth
of someone or something
> an essential component of

successful interactions in social
life as well as in professional
relationships
2. What is risk management
The Concept of risk and uncertainty are related but yet are very
different. Uncertainty involves variables that are constantly changing,
whereas risk involves only the uncertain variables that affect or
impact the system’s output directly
RISK IDENTIFICATION
RISK EVALUATION
RISK QUANTIFICATION
Risk Management Live Cycle
Risk Attitude
Risk Awareness
Risk Management
Risk Reporting
Risk Management Review
Risk Attitude
• Strategy  why and what
• Policy  how RM operates
• Appetite  risk-seeking/adverse
• Exposure  open/closed
• Tolerance  limits
Risk Awareness
Enterprise-wide Risk Management (ERM)
 Identify/analyse/categorize
 governance, management, operations, reputation,
resources, finance, strategic
 Evaluate and rank
 Probability, impact
 Identify actions
 Forecast new probability impact after actions
 Implement actions
 Accountability
Risk Management Actions
 Not only negative (ensuring that bad things are less
likely to happen)
 But also positive (making it more likely that good
things will happen)
 Not an end in itself but part of good management &
business process for determining & attaining the
strategic objectives of the organization
 Enables assessment of risk implications in terms of
governance, management, quality & reputation as
well as resources
Risk Management (RM)
 Avert potential misfortunes and disasters
 Guard against harm & damage to individuals,
infrastructure & reputation
 Minimize missed opportunities
Risk Reporting
 Risk Register
 Identify/categorize
 Evaluate
 Assign probability and impact (1 to 5)
 Treatment
 Appraised
Risk Classification
 Use probability/impact rankings
 Impact: insignificant, minor, moderate, major, catastrophic
 Probability: rare, unlikely, possible, likely, almost certain
 Identify
 Most important (red) – critical
 Moderate (yellow)
 Least important (green) –not material
Actions
 Needed when risk “red”
 Identify responsibility /accountability
 Status of risk
 Measurable
 Timeframe
 Change over time
3. Different types of risks
MARKET RISK
COMMON TYPES OF RISK CREDIT RISK
OPERATIONAL RISK
Market Risk
is defined as the risk of losses from on- and off-balance
sheet positions arising from movements in market prices.
SPECIFIC RISK
TYPES OF MARKET RISK

GENERAL MARKET RISK
INTEREST RATE RISK
EQUITY POSITION RISK

FOREIGN EXCHANGE RISK
COMMODITY POSITION RISK
LIQUIDITY RISK
CREDIT Risk
is defined as the risk of losses associated with the possibility that a
counterparty will fail to meet its obligations when they fall due, in other words
the risk that a borrower won’t repay what is owed.
COUNTRY RISK
TYPES OF CREDIT RISK
SOVEREIGN RISK
CORPORATE CREDIT RISK

RETAIL CONSUMER CREDIT RISK
SYSTEMIC CREDIT RISK
TRADED MARKETS COUNTERPARTY CREDIT RISK
OPERATIONAL Risk
as the risk of loss resulting from inadequate or failed internal processes,
people and systems or from external events.
INTERNAL PROCESSES
TYPES OF OPERATIONAL RISK
PEOPLE & SYSTEMS
EXTERNAL EVENTS
BUSINESS
STRATEGIC
REPUTATIONAL
LEGAL
4. Level of risks
Extremely High
High
Medium
Low
ROLE OF RISK MANAGER
MONITOR RISK OF A FIRM
IDENTIFY RISKS
MEASURE RISKS
REPORT RISKS
MANAGE - or CONTROL RISKS
Quantitative factors
Qualitative factors
Qualitative factors
Owners, Management
Investments: LT earnings, no over-investment in sector
Products: demand, innovation vs. cost leadership or niche
Competition: Market entry barriers, pricing power
Risk evaluation
Government regulation
Quantitative factors
Growth: Sales, Investments

Profitability: Operating and net margins, ROE
Risk: Sales and profit stability, capital structure, size,
liquidity
Valuation: Ratios (P/E, P/S, P/BV, P/CF), Discounted
Cash Flow (Focus: capital costs)
5. Methods and TOOLS of Risks
Scenario Analysis
What – If Analysis
The determination of what happens to
NPV estimates when we ask what-if
questions SIMULATION ANALYSIS
• ASSESS IMPLICATIONS OF
PARTICULAR Combination of scenario and
COMBINATIONS OF EVENTS sensitivity analysis
• NO PROBABILITY STATEMENT
Sensitivity Analysis
Investigation of what happens to
NPV when only one variable is
changed
Base, Worst, Best
Optimistic, Pessimistic
Base, Lower, Upper
5. Methods and TOOLS of Risks
STATISTICAL ANALYSIS FIND PROBABILITY OF LOSSES
HOW TO ASSESS EVENTS WHICH HAVE NEVER OCCURRED?
Technical forecasting
involves the use of historical data to predict future values.
E.g. time series models.
Fundamental forecasting
is based on the fundamental relationships between economic
variables
quantitative measurements based on regression models and sensitivity
analyses.
Methods and TOOLS of Risks
Figure 2.
Figure 1.
Risk and return according to the basic
Capital Asset Pricing Model (CAPM)
Expected Expected
return return
Risk
Risk
Look ! …………………..Expected return and risk are interdependent!

Methods and TOOLS of Risks
TWO GENERAL APPROACHES
FACTOR MODELS --- AS IN RISKMETRICS
PORTFOLIO MODELS --- AS IN ROLLING HISTORICAL QUANTILES
EVALUATE AND MINIMIZE RISKS
Portfolio formation
PORTFOLIO STANDARD DEVIATION
Market risk DOWNSIDE RISK SUCH AS SEMI -VARIANCE
VALUE AT RISK
“The higher the perceived risk, the higher the

discount rate that should be applied to
the project’s cash flows”.
EVALUATE AND MINIMIZE RISKS
Horizon
Exposure
Methods
Guess of the
market direction
Compensate
the extra risk!
How to Value A Firm
Discounted Cash Flow Analysis
Comparable Multiples
Cash Flow Analysis
Price/Book Value
etc
Investment Analysis
Investment Approach
Macroeconomic Analysis
Sector Rotation
Balance Sheet Analysis
Valuation
Chart reading
Market Indicators
Technical Indicators
Behavioral Finance
Investment Analysis
Macro analysis
Others
Inflation chart,
sentiment,
Currency analysis money flows,
Bond yields behavioral fin
earnings yields
Economic structure
Global scenarios
FDI, restruct., dereg., taxation
Valuation Techniques
Discounted Cash Flow

Weighted Avg. Cost of Capital (WACC)
Cash Flow Analysis
Comparable Multiples
P/E (trailing or
future)
Price to EBITDA
Price to Cash Flow
Price to Book Value
Enterprise
Value/EBITDA
Valuation Tools
Annual Report and Quarterly Reports

Income Statement
Balance Sheet
changes in net working capital, inventory level
Statement of Cash Flow

Financial Notes
Discounted Cash Flow Steps
Analyze
historical
performance Forecast
performance Estimate
1. Calculate historical cost of Calculate
Estimate
margins and ratios 1. Understand strategic capital value and
2. Determine value position of firm continuing
drivers 2. Select forecast horizon
value interpret
3. Analyze financial (competitive advantage
health window) results
3. Forecast individual line 1. Estimate cost of non-equity
items financing
4. Develop scenarios (best, 2. Estimate cost of equity 1. Choose methodology
worst, likely cases) financing WACC
5. Check overall forecast for 3. Determine target market APV
reasonableness weights [or iterate] for 2. Calculate free cash flows
WACC 3. Discount free cash flow
4. Calculate discount rate and continuing value to
present
4. Interpret results
Select appropriate technique
1. Multiples (e.g., EBITDA, free cash flow, net
income)
2. Perpetuity/growing perpetuity
3. Estimate the parameters
WACC Approach
Historical Projected
Risk-free rate
..
1997 1998 1999 2000 ….
Mkt risk premium
. WACC Capital structure
Cost of debt
FCF
Beta
Tax rate
Terminal
value
Discounting
PV of Net
PV of Equity
free + -
debt
=
continuing value
cash
value
flows
Value Analysis
Equity Value: Market Value - cash - hidden assets + Debt
EBITDA (Earnings Before Income Tax, Depreciation, and Amortization)

Trailing 4 quarters EBIT + D + A
EV/EBITDA multiple inverted is essentially the pretax cash flow return

on assets of the corporation
Comparable Company Multiples
P/E Revenue
Advantages  EPS is industry standard  Helps value companies with no
 Easy to put into historical earnings
context
 EPS can be measured in nearly
uniform manner
Disadvantages  Non-cash differences  Requires similar companies
 Financing/capital differences with same component revenues
 Accounting “standards” may be  Doesn’t tell you how profitable
subject to interpretation and vary the revenues are going to be
across countries
Other common measures Enterprise Value/EBITDA

P/E to 5 Year Estimated EPS Growth
Rate
Market Value of Equity/Book Value of
Equity
THANK YOU

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Introduction to Risk Management

6. EVALUATE AND MINIMIZE RISKS

> Risk factors

> Risk factors

> Ladder construct

> an essential component of

Risk Management Review

COMMON TYPES OF RISK CREDIT RISK

TYPES OF MARKET RISK

INTEREST RATE RISK

EQUITY POSITION RISK

CORPORATE CREDIT RISK

SYSTEMIC CREDIT RISK

TRADED MARKETS COUNTERPARTY CREDIT RISK

MANAGE - or CONTROL RISKS

Growth: Sales, Investments

STATISTICAL ANALYSIS FIND PROBABILITY OF LOSSES

HOW TO ASSESS EVENTS WHICH HAVE NEVER OCCURRED?

Look ! …………………..Expected return and risk are interdependent!

FACTOR MODELS --- AS IN RISKMETRICS

PORTFOLIO MODELS --- AS IN ROLLING HISTORICAL QUANTILES

Market risk DOWNSIDE RISK SUCH AS SEMI -VARIANCE

“The higher the perceived risk, the higher the

Cash Flow Analysis

Discounted Cash Flow

Cash Flow Analysis

Annual Report and Quarterly Reports

Statement of Cash Flow

EBITDA (Earnings Before Income Tax, Depreciation, and Amortization)

EV/EBITDA multiple inverted is essentially the pretax cash flow return

Other common measures Enterprise Value/EBITDA

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