erm test 1 questions & answers 2024/2025
What is risk - ANSWERSRisk is a variable that can cause deviation from an expected outcome, and as such may affect the achievement of business objectives and the performance of the overall organization
Risk is uncertainty—it can have upside or down...
What is risk - ANSWERSRisk is a variable that can cause deviation from an expected outcome, and as
such may affect the achievement of business objectives and the performance of the overall organization
Risk is uncertainty—it can have upside or downside. opportunity cause and effect. risk can lead to
opportunity.
If I have no risk with 100% certainty—then what is risk—it's uncertainty.
no exact answer/result/icome
risk vs return and risk vs reward
who sets risk appetite - ANSWERSboard, not elon musk.
Exposure: - ANSWERSrisk exposure is the maximum amount of economic damage resulting from an
event.
evaluation of worst case scenario
Volatility - ANSWERSa measure of uncertainty, the variability in potential outcomes
the greater the vol, the greater the risk (or return). Bond traders love vol. In mkt risk, volatility means the
std deviation of returns.
ppl trade more if more vol. investorrs like this. >v,>s
Severity - ANSWERSamount of damage likely to be suffered
take 100$ stock position eg—exposure=100; severity prob a lot less; > the vol, the > the severity
expected dollar loss of negative thing that happened.
,Time Horizon - ANSWERSduration of risk exposure or how long it will take to reverse the effects of a
decision or event
>duration >risk think 10 yr treasury vs 10 yr gnma vs auction rate securities vs structured derivatives
For time horizon mitigation monitoring, preparation, and rapid response are key to survival
For cyber think malware detection (dwell time) and risk mitigation (response time); slow to realize attack
lengthens time horizon of risk
Correlation - ANSWERShow risks in a business are related to one another. (clwr cash eg)
if 2 risks behave similarly, they increase for the same reasons or by same amt, they are highly correlated.
Risk diversification in business is inversely related to the level of correlation in within the business. Price
correlations approach 1.0 during times of crisis. Flight to quality. lots of things go south.
Capital: - ANSWERScompanies hold capital for two reasons
2)To cover unexpected losses arising from risk exposures. (absorb shocks: ex: interest rates go
up/inflation/int rate risk)
don't have to have many home runs to crush it
how to make e risk mgt work - ANSWERSsupport from the top (senior execs)
know that evryone has risks
Capital Allocations: - ANSWERSthe allocation of capital to specific business units links risks and return
and allows the profitability of all business units to be compared on a consistent risk adjusted basis
The combination of economic capital, human capital, and liquidity reserves represents the "risk capacity"
of the company.
I never have enough money to invest in all of my business units—how do I allocate scarce capital?
credit ratings - ANSWERSMoody's
S&P
Fitch
,Others
A credit rating is an estimate of how likely a company is to fail.
How do credit agencies do in crisis?
Debt ratings affect my cost of debt—where do I want to be? Why?
Ratings agencies tend to be a lagging indicator. if ur waiting for a ratings agency like s&p to understand
the company its too late by the time the ratings company downgrades a company the smart ppl have
already figured it out. investors in Walmart not waiting for downgrade, the best hedge funds is ahead. if
ur waiting for ratings agency uu already lost
Do comparison of Duke Power & Peter Thiels Companies (Founders FundMithril/paypal/facebook first
investor 10% for $500k) or True Ventures
what does risk look like - ANSWERSRisk is a bell curve with a distribution of outcomes
Each point on the curve represents a different possible outcome
no right or wrong just dif outcomes
Symmetrical Risk: - ANSWERS: risks like interest rate risk or mkt risk; equal prob of gains or losses
looks like its curved. just as many downside to upside
Asymmetrical Risk - ANSWERScredit risk or operational risk—typically thought of as more downside than
upside; disruptive technologies can actually have more upside than down.
Risks can be asymmetrical with more upside too—disruptive technologies
focus on asym risk bc more likely you'll lose/downside
risk mgrs tend to focus on the - ANSWERSdownside. Downside risk analysis can inform capital
management, hedging, insurance, and contingency planning
Analysis of expected value can support - ANSWERSfinancial planning , pricing, budgeting etc while upside
risk analysis can shape strategic planning and investment decisions. Upside analysis moves the bell curve
to the right
, The objective of mgt is to optimize the shape of the bell curve. Est risk appetite strategies and and risk
transfer strategies to control the downside. Strategic planning and implementation should drive the
mean to the right by increasing expected earnings and intrinsic value.
Most people, especially accountants don't focus enough on the upside—What can I do that drives
extraordinary returns
ERM is - ANSWERSan integrated and continuous process for managing enterprise wide risks—including
strategic, financial, operational, compliance, and reputational risks—in order to minimize unexpected
performance variance and maximize firm value.
Risk management is about optimizing risks - ANSWERS1)understanding the risk interdependencies across
risks and implementing integrated strategies
2)The goal of ERM is to minimize unexpected performance (defensive applications) and to maximize firm
value (offensive applications)
3)An ERM program supports better decisions at the board and management level.
Are we swinging for the fences or managing to a 9% return with low likelihood of misses?
Responses to Risk—Start with Inherent Risk and End with Residual Risk - ANSWERSAccept
Mitigate
Transfer
Exit
Risk management
4 responses
Start with inherent or gross risk
Then mitigate all you can
Then transfer/insure what you are still uncomfortable with
What's left is residual risk
If you make funnel to long and skinny—nothing gets thru it—not always good either
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