FUNDAMENTALS OF RISK MANAGEMENT

1. Pure risks are risks that offer only the prospect of a loss. Examples include
the risk that a plant will be destroyed by fire or that a product liability suit will
result in a large judgment against the firm.
2. Speculative risks are situations that offer the chance of a gain but might
result in a loss. Thus, investments in new projects and marketable securities
involve speculative risks.
. Demand risks are associated with the demand for a firm!s products or
services. "ecause sales are essential to all businesses, demand risk is one of
the most significant risk that firms face.
#. Input risks are risks associated with input costs, including both labour and
materials. Thus, a company that uses copper as a row material in its
manufacturing process faces the risk that the cost of copper will increase and
that it will not be able to pass this increase on to its customers.
$. Financial risks are risks that result from financial transactions. %f a firm plans
to issue new bonds, it faces the risk that interest rates will rise before the
bonds can be brought to market. &imilarly, if the firm enters into contracts with
foreign customers or suppliers, it faces the risk that fluctuations in exchange
rates will result in unanticipated losses.
'. Property risks are associated with destruction of productive assets. Thus, the
threat of fire, floods, and riots imposes property risks on a firm
(. Personnel risks are risks that result from employees! actions. Examples
include the risks associated with employee fraud or embe))lement, or suits
based on charges of age of sex discrimination.
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December 1-2, 2008
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*. Environmental risks include risks associated with pollution he environment.
+ublic awareness in recent years, coupled with the huge costs of
environmental cleanup, has increased the importance of this risk.
,. Liability risks are associated with product, service, or employee actions.
Examples include the very large judgments assessed against asbestos
manufacturers and some health care providers, as well as costs incurred as a
result of improper actions of employees, such as driving corporate vehicles in
a reckless manner.
1-. Insurable risks are risks that can be covered by insurance. %n general ,
property, personnel, environmental, and liability risks can be transferred to
insurance companies. .ote, though, that the ability to insure a risk does not
necessarily mean that the risk should be insured. %ndeed, a major function of
risk management involves evaluating all alternatives for managing a particular
risk, including self/insurance, and them choosing the optimal alternative.

RISK MANAGEMENT AND AVOIDANCE
4 WAYS TO DEAL WITH RISK
There are four ways of dealing with or managing each risk that you have
identified. 0ou can1
Accept it
Transer it
Red!ce it
"liminate it
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December 1-2, 2008
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MICROSOFTS GOAL : MANAGE EVERY RISKS
Twenty years ago, risk management meant buying insurance against fire, theft,
and liability losses. Today, though, due to globalisation, volatile markets, and
a host of lawyers looking for someone to sue, a multitude of risks can
adversely affect companies. 2icrosoft addressed these risks by creating a
virtual consulting practice, called 2icrosoft 3isk 4o. to help manage the risks
faced by its sales, operations, and product groups.
&cott 5ange, head of 2icrosoft 3isk, in an article identified these 12 major
sources of risk1
1. Business partners 6interdependency, confidentiality, cultural conflict,
contractual risks7
2. Competition 6market share, price wars, industrial espionage, antitrust
allegations etc.7
. Customers 6product liability, credit risk, poor market timing, inade8uate
customer support7.
#. Distribution systems 6transportation, service availability, cost, dependence
on distributors7
$. Financial 6foreign exchange, portfolio, cash, interest rate, stock market7.
'. Operations 6facilities, contractual risks, natural ha)ards, internal processes
and control7.
(. People 6employees, independent contractors training staffing inade8uacy7
International Commodity Trading and Risk Management
December 1-2, 2008
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*. Political 6civil unrest, war, terrorism, enforcement of intellectual property
rights, change in leadership, revised economic policies7.
,. Regulatory and legislative 6antitrust export licensing, jurisdiction, reporting
and compliance, environmental7.
1-. Reputations 6corporate image, brands, reputations of key employees7.
11. Strategic 6mergers and ac8uisitions, joint ventures and alliances, resource
allocation and planning, organi)ational agility7.
12. ec!nological 6complexity, obsolescence, the year 2--- problem, workforce
skill sets7.
AN APPROACH TO RISK MANAGEMENT
1. %dentify the risks faced by the firm.
2. 2easure the potential effect of each risk.
. 9ecide how each relevant risk should be handled.
:. Transfer the risk to an insurance company.
". Transfer the function that produces the risk to a third party.
4. +urchase derivative contracts to reduce risk.
9. 3educe the probability of occurrence of an adverse event.
E. 3educe the magnitude of the loss associated with an adverse event.
;. Totally avoid the activity that gives rise to the risk.
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