FINANCIAL CONTROLLERSHIP

NAME: DONNA KAYE LU DATE: APRIL 20, 2024

COURSE: BSBA FM-3 BLOCK 1 SUBJECT: FINANCIAL CONTROLLERSHIP

TOPIC: RISK MANAGEMENT

Research and review the following outlined topics:

1. Explain what is Risk
 Risk is defined in financial terms as the chance that an outcome or investment's
actual gains will differ from an expected outcome or return. Risk includes the
possibility of losing some or all of an original investment.
2. Explain the following types of Risks and give each an example.
a. Systematic Risk- Systematic risk, also known as market risk, affects the entire
market and cannot be diversified away. It includes factors such as economic
downturns, inflation, interest rate fluctuations, and geopolitical events.
Example: During a global recession, stock markets around the world experience
significant declines in value due to widespread economic downturns, impacting all
types of investments.
b. Unsystematic Risk- Unsystematic risk, also called specific risk or diversifiable risk,
is unique to a particular company or industry and can be reduced through
diversification.
Example: A company's stock price drops sharply following a product recall, causing
financial losses for investors who had heavily invested in that particular company.
c. Political/Regulatory Risk- Political or regulatory risk refers to the potential impact
of governmental actions or changes in regulations on businesses and investments.
Example: A pharmaceutical company faces financial losses after a government
agency imposes stricter regulations on drug pricing, reducing profitability and market
access.
d. Financial Risk- Financial risk involves the possibility of financial loss due to factors
such as debt, leverage, liquidity, and creditworthiness.
Example: A highly leveraged real estate developer defaults on its loan obligations
during a housing market downturn, leading to bankruptcy and foreclosure of its
properties.
e. Interest Rate Risk- Interest rate risk refers to the potential impact of changes in
interest rates on investments or financial instruments.
Example: Bond prices decline as interest rates rise, causing losses for bond investors
who hold fixed-income securities with lower yields compared to newly issued bonds.
f. Country Risk- Country risk encompasses political, economic, and social factors that
affect investments in a particular country.
Example: A multinational corporation faces financial losses and operational
disruptions due to political instability and civil unrest in a country where it operates
manufacturing facilities.
g. Social Risk- Social risk involves factors related to societal attitudes, behaviors, and
trends that can impact businesses and investments.
Example: A consumer goods company faces reputational damage and loss of market
share after being accused of using child labor in its supply chain, leading to consumer
boycotts and negative publicity.
h. Environmental Risk- Environmental risk refers to the potential impact of
environmental factors such as pollution, climate change, natural disasters, and
regulatory actions on businesses and investments.
 Example: An oil company faces legal and financial liabilities after a major oil spill
contaminates marine ecosystems, leading to lawsuits, clean-up costs, and reputational
damage.
i. Operational Risk- Operational risk arises from internal processes, systems, and
human error that can result in financial losses or disruptions to business operations.
Example: A manufacturing company experiences production delays and quality
issues due to equipment malfunctions, leading to increased costs and customer
dissatisfaction.
j. Management Risk- Management risk, also known as executive risk, refers to the
potential impact of managerial decisions, competence, and integrity on the success of
a business or investment.
Example: A publicly traded company's stock price declines sharply after the CEO is
implicated in a corporate scandal involving accounting fraud, damaging investor
confidence and shareholder value.
k. Legal Risk- Legal risk involves the potential impact of lawsuits, regulatory actions,
and legal disputes on businesses and investments.
Example: A pharmaceutical company faces lawsuits and regulatory scrutiny over
allegations of product defects and safety concerns related to one of its prescription
medications, leading to costly litigation and regulatory fines.
l. Competition Risk- Competition risk refers to the potential impact of competitive
forces and market dynamics on businesses and investments.
Example: A retail chain loses market share and revenue to online competitors
offering lower prices and greater convenience, forcing the company to close stores
and downsize its workforce.
m. Credit Risk- Credit risk, also known as default risk, is the potential loss arising from
the failure of a borrower to repay a loan or meet contractual obligations.
Example: A bank experiences loan defaults and credit losses as borrowers fail to
repay their mortgages and personal loans during an economic recession, leading to a
decline in the bank's profitability and solvency.
n. Compliance risks- Compliance risk involves the potential impact of non-compliance
with laws, regulations, and industry standards on businesses and investments.
Example: A financial services firm is fined by regulatory authorities for violating
anti-money laundering regulations and failing to conduct proper due diligence on
high-risk clients, damaging its reputation and shareholder value.
o. Reputational Risk- Reputational risk refers to the potential impact of negative
publicity, public perception, and stakeholder sentiment on the reputation and brand
value of a company or investment.
Example: A social media company faces public backlash and user boycotts after a
data breach exposes the personal information of millions of users to hackers, leading
to a loss of trust and credibility.
p. Human Resource Risk- Human resource risk involves factors related to workforce
management, employee relations, and talent acquisition that can impact
organizational performance and stability.
Example: A technology company struggles to retain top talent as key employees
leave for better job opportunities at rival firms, impacting its ability to innovate and
compete in the market.
q. Information Technology Risk- Information technology risk encompasses threats and
vulnerabilities related to the use of technology and digital systems in business
operations.
 Example: A healthcare organization experiences a cyberattack that compromises
patient data and disrupts critical systems, leading to breaches of patient
confidentiality and regulatory penalties.
r. Control or uncertainty risks- Control or uncertainty risks arise from factors that are
beyond the organization's control or are uncertain in nature.
Example: A tourism industry suffers losses due to cancellations and disruptions
caused by a volcanic eruption in a popular tourist destination, leading to uncertainty
and volatility in the travel industry.
s. Opportunity or Speculative risks- Opportunity or speculative risks refer to the
potential for gains or losses associated with pursuing new ventures, investments, or
strategies.
Example: An entrepreneur invests in a startup company with innovative technology
and high growth potential, knowing that there is a possibility of significant returns but
also a risk of failure due to market competition and funding constraints.
3. Discuss and give example what is inherent risks.
 Inherent risks are risks that are inherent or inherent in a business or activity and
cannot be eliminated through risk management efforts. These risks are inherent to
the nature of the business or activity itself and are typically present regardless of
the control measures implemented. For example, the inherent risks associated
with investing in the stock market include market volatility, economic downturns,
and geopolitical events. Similarly, the inherent risks of operating a manufacturing
facility include supply chain disruptions, equipment failures, and regulatory
compliance issues. Inherent risks must be identified, understood, and managed
effectively to mitigate their impact on the organization.
4. Explain the following level of risks and give each examples:
a. Low Risk- Low-risk activities or investments have a minimal likelihood of adverse
outcomes and typically involve predictable and stable conditions. For example,
investing in government bonds or savings accounts with guaranteed returns is
considered low risk.
b. Medium Risk- Medium-risk activities or investments have a moderate likelihood of
adverse outcomes and may involve some degree of uncertainty or volatility.
Examples include investing in diversified mutual funds or starting a small business
in a stable industry.
c. High Risk- High-risk activities or investments have a significant likelihood of
adverse outcomes and often involve greater uncertainty, volatility, or potential for
loss. Examples include investing in individual stocks, launching a startup in a
competitive market, or participating in speculative trading.
d. Critical Risk- Critical risks pose the highest level of potential harm or loss to the
organization and may have severe consequences if not managed effectively.
Examples include exposure to catastrophic events such as natural disasters, major
financial crises, or regulatory violations that could lead to significant legal or
reputational damage.
5. Explain what is Operational Disruption
 Operational disruptions are events that affect the normal flow of business
activities, such as natural disasters, cyberattacks, supply chain issues, or staff
shortages. They can have serious consequences for your productivity,
profitability, customer satisfaction, and reputation.
6. Provide and explanation of the following categories of Operational Disruptions and
give each at least two (2) examples.
 a. People- Operational disruptions related to people involve issues related to workforce
management, employee availability, skills, and behavior that can impact business
operations.
Examples:
 Staff shortages: A retail store experiences operational disruptions during peak
hours due to inadequate staffing levels, leading to long wait times for customers
and decreased service quality.
 Employee strikes: A manufacturing company faces production delays and supply
chain disruptions as workers go on strike to protest against wage cuts and working
conditions, impacting production schedules and customer orders.
b. Premises- Operational disruptions related to premises involve issues related to the
physical facilities, infrastructure, and utilities that are essential for business
operations.
Examples:
 Facility damage: A warehouse facility suffers structural damage during a severe
storm, rendering it unsafe for operations and causing delays in receiving and
shipping goods.
 Utility outages: A restaurant experiences operational disruptions when a power
outage occurs, leading to the loss of refrigerated inventory, inability to cook food,
and temporary closure until utilities are restored.
c. Processes- Operational disruptions related to processes involve issues related to
workflows, procedures, and systems that are necessary for the efficient execution of
business activities.
Examples:
 System failures: An online retailer experiences operational disruptions when its e-
commerce website crashes due to a server outage, preventing customers from
placing orders and processing payments.
 Supply chain disruptions: An automotive manufacturer faces production delays
and inventory shortages due to disruptions in its supply chain caused by
transportation bottlenecks, raw material shortages, or supplier bankruptcies.
7. Define and explain what is Risk Management
 Risk management involves identifying, analyzing, and accepting or mitigating
uncertainty in investment decisions. Put simply, it is the process of monitoring
and dealing with the financial risks associated with investing. Risk management
essentially occurs when an investor or fund manager analyzes and attempts to
quantify the potential for losses in an investment, such as a moral hazard, and then
takes the appropriate action (or inaction) to meet their objectives and risk
tolerance.
8. Discuss the following components of Risk Management and give each examples:
a. Risk Identification- Risk identification involves identifying potential risks that may
impact the achievement of organizational objectives. This includes both internal and
external risks across various areas of the business.
Example: A manufacturing company identifies supply chain disruptions, equipment
failures, and regulatory changes as potential risks that could impact production
schedules and profitability.
b. Risk Assessment- Risk assessment involves evaluating the likelihood and potential
impact of identified risks on the organization's objectives. This helps prioritize risks
based on their significance and develop appropriate risk management strategies.
 Example: A financial institution assesses the credit risk of its loan portfolio by
analyzing borrowers' creditworthiness, default probabilities, and potential loss
exposures under different economic scenarios.
c. Risk Mitigation- Risk mitigation involves implementing measures to reduce the
likelihood or impact of identified risks. This may include implementing controls,
developing contingency plans, or transferring risk to third parties.
Example: A software company mitigates cybersecurity risks by implementing
firewalls, encryption protocols, and employee training programs to prevent data
breaches and unauthorized access to sensitive information.
d. Risk Reporting- Risk reporting involves communicating information about identified
risks, their assessment, and mitigation measures to stakeholders, including
management, board members, and regulatory authorities.
Example: A risk management committee prepares monthly risk reports for the board
of directors, highlighting key risks, their current status, and any emerging issues that
require attention or action.
e. Risk Monitoring- Risk monitoring involves tracking and evaluating the effectiveness
of risk management activities over time. This includes regular review of risk
indicators, performance metrics, and early warning signals to identify changes in risk
exposure.
Example: An investment firm monitors market trends, economic indicators, and
portfolio performance to assess the impact of changing market conditions on
investment returns and adjust asset allocations accordingly.
f. Risk Governance- Risk governance involves establishing structures, processes, and
responsibilities for managing risks effectively throughout the organization. This
includes defining risk management policies, roles, and decision-making authority.
Example: A multinational corporation establishes a risk management committee
comprised of senior executives from different business units to oversee enterprise-
wide risk management activities and ensure alignment with strategic objectives.
9. Explain what is Risk Treatment Strategy
 A risk treatment strategy involves selecting and implementing appropriate actions
to address identified risks. This may include avoiding, mitigating, transferring, or
accepting risks based on their significance and organizational objectives.
10. Explain the following Risk management Strategy and give each example.
a. Diversification- Diversification involves spreading investments across different
assets, industries, or geographic regions to reduce overall risk exposure.
Example: An investor diversifies their portfolio by investing in stocks, bonds, real
estate, and commodities to minimize the impact of market fluctuations on investment
returns.
b. Hedging- Hedging involves using financial instruments or strategies to offset the
potential losses from adverse price movements in an underlying asset.
Example: A commodity producer hedges against price volatility by entering into
futures contracts to lock in selling prices for future production, protecting against
declines in commodity prices.
c. Insurance- Insurance involves transferring the financial risk of potential losses to an
insurance company in exchange for premium payments.
Example: A homeowner purchases property insurance to protect against the financial
losses from property damage or theft caused by covered perils such as fire, theft, or
natural disasters.
d. Operating Practices- Operating practices involve implementing policies, procedures,
and controls to mitigate operational risks and improve business resilience.
 Example: A manufacturing company adopts lean production practices and
implements quality control measures to minimize defects, reduce waste, and improve
operational efficiency.
e. Deleveraging- Deleveraging involves reducing debt levels and financial leverage to
lower the risk of financial distress and default.
Example: A highly leveraged company sells non-core assets and uses the proceeds to
pay down debt, reducing its leverage ratio and improving its financial stability and
creditworthiness.
11. Discuss the following Risk Treatment Strategy:
a. Transfer- Risk transfer involves shifting the financial consequences of a risk to
another party, such as an insurance company or a contractual agreement. By
transferring risk, the organization outsources the potential impact of the risk to a third
party, reducing its exposure to financial losses.
b. Treatment- Risk treatment involves implementing measures to mitigate or reduce the
likelihood or impact of identified risks. It focuses on taking proactive actions to
manage risks effectively, such as implementing controls, developing contingency
plans, or improving processes to address vulnerabilities.
c. Tolerate- Risk tolerance involves accepting the likelihood or impact of a risk without
taking specific action to mitigate it. Organizations may choose to tolerate certain risks
when the cost of mitigation outweighs the potential impact of the risk, or when the
risk is deemed acceptable within predefined thresholds.
d. Terminate- Risk termination involves ceasing or discontinuing activities or
operations that pose unacceptable risks to the organization. When risks cannot be
effectively managed or mitigated, organizations may opt to terminate the associated
activities or projects to eliminate the risk entirely.
12. Discuss the following principles of Risk Management:
a. Proportionate- The principle of proportionality states that risk management efforts
should be commensurate with the significance and complexity of the risks faced by
the organization. It emphasizes the need to allocate resources and efforts in
proportion to the level of risk exposure, ensuring that risk management activities are
balanced and appropriate.
b. Aligned- The principle of alignment emphasizes the importance of integrating risk
management with the organization's objectives, strategy, and decision-making
processes. It ensures that risk management practices are aligned with the
organization's goals and priorities, enabling effective risk-informed decision-making.
c. Comprehensive- The principle of comprehensiveness requires considering all
relevant risks across the organization's operations, including strategic, financial,
operational, and compliance risks. It emphasizes the need to take a holistic approach
to risk management, addressing all material risks that could impact the organization's
objectives and success.
d. Embedded- The principle of embedding risk management involves integrating risk
management into the organization's culture, processes, and governance structures. It
emphasizes the importance of making risk management a part of everyday operations
and decision-making, ensuring that risk considerations are ingrained in the
organization's DNA.
e. Dynamic- The principle of dynamism emphasizes the need for risk management
practices to be adaptive and responsive to changes in the internal and external
business environment. It recognizes that risks are constantly evolving and requires
organizations to regularly review and update their risk management practices to
remain effective and relevant over time.
Prepared by:

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