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68 Cards in this Set
- Front
- Back
The theory of risk management |
Volatility of protect returns should be managed if they can generate higher returns by managing risky projects. |
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Risk and stakeholder conflict |
Risk profile matches the shareholder portfolio. Altering risk profile such as increasing risk would lead to shareholders increasing required returns. |
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Risk policy decisions are made based on |
Type of business area Operating gearing Financial gearing Accuracy of forecasts |
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Types of business area and how it affects riskiness |
Economic volatility of industry Degree of seasonality Intensity of competitor action |
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Operation gearing and how it affects riskiness |
Proportion of fixed costs to variable costs in cost structure. Outsourcing vs providing internally Leasing vs buying Full time staff vs freelance providers |
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Financial gearing and how it affects riskiness |
Increasing debt reduces CoC but increases risk of bankruptcy |
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Accuracy of forecasts |
Investment program relies heavily on accuracy of cash flow forecasts |
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What must the risk framework cover |
Risk awareness Risk assessment and monitoring Risk management |
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Risk management |
Strategies for dealing with risk and planned responses should unprotected risks materialize. |
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Risk awareness |
Estimates in forecasts. Identify risk and probability of occurrence. Strategic, tactical, and operational. |
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Strategic risks |
Affect overall direction of project. Macroeconomic or change in corporate policy. |
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Operational risk |
Those affecting day to day running of project Production breakdown Breakdown of supply chain Failure of distribution networks Breakdown of supply chain Failure to recruit staff |
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Key decisions about risk assessment |
Assessment frequency, criteria for risk categorization and how often assessments should be updated. |
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Internal audit |
Assist in creation and successful running of monitoring systems |
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Information systems and risk monitoring |
Ensure that any changes affecting project estimates are: Recorded Brought to the attention of the responsible managers Dealt with in an appropriate way |
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Management information systems |
Feeding back operational data to allow for action to prevent or mitigate risk |
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Executive information systems |
Bring executives up to date with external information. |
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Mitigation |
Controls. Benefits should outweigh costs |
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Hedging the risk |
Some sort of transaction, designed to minimise exposure to unwanted business risk. Purchase or sale of a derivative security in order to neutralize all or part of a risk. |
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Prefect hedge |
Eliminate prospects of any future gains or losses |
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Diversification |
Involves reducing impact of one protect by having a portfolio of different ongoing projects. |
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4T approach to risk management |
Tolerate it Transfer it Terminate it Treat it |
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Likelihood and impact matrix |
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Tolerate |
Accept risk will occur but don't put in place any systems to manage it |
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Transfer |
Pass on the risk to someone else. Insure Take out fixed price contracts Outsource production |
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Terminate |
Deciding against project activity altogether. Or in projects bail out |
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Treat |
Controls to reduce likelihood or consequences of event occurring |
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Political risk |
Risk a company will suffer a loss as a result of actions taken by government or people of a country |
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Sources of political risk |
Exchange control regulations Import quotas Import tariffs Insist on minimum local shareholding Company structure (all joint ventures only) Discriminatory action Financing decisions |
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Exchange control regulations |
Rationing supply of foreign currency to prevent locals buying foreign goods. Banning repatriation. |
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Discriminatory action |
Prevent profitability of foreign organisation Super taxes Restricted access to local borrowing (foreign more expensive) Expropriating assets |
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Expropriation assets |
National government sizes property through national issues. Must give prompt consideration at fair value in a convertible currency |
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Measurement of political risk |
Old hands Grand tours Commercially produced Surveys Quantitative measures |
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Micro political risk |
Specific to an industry, company or project within the host country. |
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Macro political risk |
General political risk affecting all organizations within a country |
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Old hands |
Experts provide advice on risk of investment in a particular country |
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Grand tours |
Group of employees sent to a potential country to act as an inspection team. |
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Surveys |
Commercially produced databases to rate political risk using Oracle of Delphi. |
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Management of political risk prior to investment |
Planned local ownership Pre trading agreements Political risk insurance |
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Management of political risk during investment |
Production strategies Control of processes Distribution control Market control Location |
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Planned local ownership |
Target dates for release of shares into local ownership in order to create benefit for local government over time |
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Pre trading concessions and agreements |
Agreements with local authorities about rights, responsibilities, remittance and local equity investments. |
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Political risk insurance |
Transfer risk by taking out an insurance policy |
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Production strategy |
Outsourcing to locals loss of control Produce directly in host country Import from parent branch |
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Market control |
Securing markets through copywriting, patents and trademarks to deter political intervention |
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Local finance |
Local finance means any damaging intervention by government also harms local industry. |
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Borrow worldwide |
Discourages expropriation because company defaulting in loans will impact worldwide. |
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Economic risk |
Long term exchange rate risk that affects value of a company. PV of future cash flows. Also local economic conditions. |
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What does economic risk affect |
Affordability of exports (competitiveness) and imports (profitability) Value of repatriated profits |
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Direct currency risk |
If the firms home currency strengthens, their predicts are less competitive due to being more expensive |
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Indirect currency risk |
If their are two foreign competitors and home currency strengthens vis a vis the customer's home currency the competitor is going to derive a competitive advantage. |
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Managing economic risk |
Diversification of production and supply Diversification of financing |
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Regulatory risk |
potential for laws related to a specific entity to change and affect: How the business as a whole can operate The viability of planned and ongoing investments |
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How to manage regulatory risk |
Incorporate the role within internal audit Consult a firm specialising in regulatory risk |
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Compliance risk |
Risk of losses associated with not complying with regulation |
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Fiscal risk |
Risk of government assuring tax policy to raise more revenue |
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How to factor risks into investment appraisal |
Expected values Use of the CAPM model Sensitivity analysis and simulation |
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Probability analysis |
Sum of each outcome multiplied by its probability |
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Conditional probability |
Probability of one outcome dependent on another outcome |
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Sensitivity analysis |
Measures change in a particular variable which can be tolerated before the NPV of a project reduces to zero. |
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Sensitivity analysis formula |
NPV of project/ PV of cash flows affected by the estimate |
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Simulation |
Assess the impact of more than one veritable at a time. Employs random numbers to generate multiple different NPVs to get a distribution. Assumes variables are uncorrelated. |
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Value at risk |
Measure of how much the market value of asset portfolio is likely to decrease over time under normal market conditions. |
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VaR formula |
Standard deviation*time^1/2*confidence interval |
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Derivative |
An asset whose value depends on an underlying asset. Not fixed in volume since their creation depends on existence of counterparties. |
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Counter party credit risk |
You make a profit on your derivative, the corollary makes a loss but then defaults in paying you your profit. |
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How to manage counter party credit risk |
having the clearing house act as the official counter party for every transaction |
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marking to market |
Daily profit or loss added or subtracted from margin account |