Risk management is a crucial financial concept involving a systematic framework to identify, assess, mitigate, and monitor potential threats that could prevent an organization from achieving its objectives, with a particular focus on financial risks.
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Risk management is a very important concept
concept
and in fact there's a section of the
syllabus section E that is solely
devoted to risk management and you can
alludes to why because in that
particular section we'll be dealing with
a lot of edging method using derivatives
to manage risk. However, this video will
focus on mostly the theoretical part of
risk management which is you
understanding the risk management
frameworks. How risk can be manage from
identification to assessment to
mitigation and monitoring. Right? So
that's what I'm going to be talking
about today. However, when we get to
section E of the syllabus, we go into
calculation on edging and all of that.
So remember why do we need to do risk
management? Because as finance managers
we always plan and what we have learned
over time is that plan will not be
always the same as actual. So our result
will not exactly be the same thing as
So there is that possibility that it
will not be the same. We know definitely
it can be better which means our actual
can be better or it can be worse. If it
is better then we are fine.
We don't have problem but where we have
problem is when it is worse. When our
plan is actually better than our actual
which is the same thing as when our
actual is worse than our plan. We don't
want that.
So the objective of risk management is
So we want to minimize bad surprises as
Yeah.
So before I go into
the risk management details few concepts
that you need to understand which I see
student getting confused about and the
first one is exposure.
You need to know what is exposure and
exposure is simply the basis of your
risk. That is what is at stake. Yeah.
What what are your concerns? Yeah.
Yeah.
What is the basis of you having such
fear of actual not the same as your
plan? What are you afraid of? So that is
your exposure. So we're talking about
our concern.
Why are we even talking about risk? Why
that will give us that kind of concern.
That's exposure. There's also a concept
And volatility is how quickly or how
often your exposure can change. Yeah. So
So take for instance if you take a loan
your exposure is interest rate because
if you have a borrowing you don't want
interest rate to go up. So you have an
exposure interest rates going up is a
problem for you. The volatility is about
how quickly that interest rate can
change. So your volatility remember is
about things changing so fast. Yeah,
that's volatility.
Very important. And also you need to
understand what we mean by severity.
And severity is just the value of a
What can you lose? What is
the amount of loss you will suffer?
Yeah, that is your severity. How bad can
it be? Yeah, how bad can you loss? Okay,
that's your severity.
Then we have probability.
Yeah, probability is looking at the
likelihood that the risk will
crystallize. So this is about likelihood of
of risk
risk crystallizing
Yeah. Or you call it occurrence
likelihood of occurrence.
Yeah. So that's probability
very important. So now what is risk? I
always tell you risk is just anything
that can stop a company from achieving
its objective. That is the meaning of
risk. What that can stop you from
achieving your objective is the risk
we're talking about. And quickly I will
that you need to be conversant with. The
most important one which will focus on
in this paper is majorly the financial risk.
risk.
Yeah. Though there are other types of
risk which I'm going to quickly touch on
but please take note these our focus for
this paper. And when we get to edging in
section E these are the types of risk
we'll be focusing on edging. And when
you're talking of financial risk, there
are three types of risks you are looking
at. You're looking at the credit risk,
and you're looking at market risk.
And quickly, credit risk is default
risk. So, which usually come
as a result of the asset that you have
take. For instance, account receivable.
When you have account receivable, you
have a credit risk. And the risk is that
your customers will default on their payment.
payment.
So which means you might not be able to
recover the value from your asset. So
when you have an asset, you are exposed
to credit risk. And liquidity risk is a
risk that you might not have enough
money to pay or to settle your
obligation. So usually when you have a
liability, you are exposed to liquidity risk.
risk.
Because with this one you might be
subject to sovereignty if you're not
able to pay your obligation.
So this is about you being able to match
your assets to your liability such that
you have enough cash to settle your
obligations as def. And the third one
for financial risk is the market risk.
And remember market risk can even still
be subdivided into price risk, the FX
risk and the interest rate risk.
You touch this in FM, right? So the
likelihood that change in price or
change in FX rate or change interest
rate might lead to a loss of money is
your market risk. So the possibility of
having a financial loss. So in all of
these three risk
you are afraid of having a financial
loss because of changes that could
happen in price in FX or interest rate
or the fact that you don't have enough
liquid assets to pay your liability or
the people that are owing you are unable
to pay what they are owing you and you
might lose some money there. So that's
financial risk which we'll be focusing
on. But there are other types of risk
that you need to at least understand.
And the next one I'm touching on is the
operating risk.
Yeah. And from the word operating risk,
I'm sure you can relate with it. Yeah.
Usually this is associated with the
nature of business. So because you're
operating a particular area. Yeah.
Almost like a business risk. Yeah. So
nature of your
business. Yeah. Can also call it your
Yeah. So my
strategy might fail
or you might even lose cop staff. Maybe
turnover is high or people that are
quite experienced in your business. They
might leave you and might affect your
business or your operations. You might
not be able to operate properly. So
these are the kind of risk that you will
find in a company. Yeah.
So very important to note this. Yeah.
However, like I said, our focus is on
financial risk. Yeah. So now let's go
into risk management proper.
Risk management. So anytime you hear
risk management, please four things must
come to your mind. Four things.
The first one is the fact that you need
to identify the risk. So first of all is
identification and this concept is so
important because it is the same
all over the sectors all over the
curriculums any paper you are doing any
exams you are writing even if not ACC if
it's CFA if it's CPA whatever risk
management is risk management so that's
why it's good to just understand it now
and understand it once and for all so
the first step is to identify the risk
once you've identified the risk is we
listed them out. Then the next thing is
to do an assessment of the risk.
And why is it important to do an
assessment? Because if you don't do an
assessment, you don't know how to
mitigate your risk. Your assessment is
trying to help you determine how
important the risk are. Because you've
probably identified 20 risk, you should
be able to prioritize them. Which ones
are really major risk and which ones are
not really something you should be
bothering about. So your assessment will
help you to ensure that your investment
in mitigation is just enough and
commenurate to the amount of risk that
you are talking about. So you are not
trying to get a gun to kill an insect.
Okay. So and what are you doing when
you're doing assessment? What you are
trying to do is you are checking the
likelihood that the risk will actually crystallize.
