Risk Management APR

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CHAPTER I
RISK MANAGEMENT
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INTRODUCTION
The word risk is derived from an early Italian word risicae which means to dare. The story of mankind is a story of threats and opportunities, of braving the risks and getting the rewards in the process. We may define risk emanating from a situation as something which throws a challenge to an act or not to act with regard to an event or happening. These challenges (or risks) under the different walks of life may take various forms. A soldier may the risk of life in a battle and a traffic police may run the risk of being hit by an automobile on the road. Thus, the concept of risk is synonymous with the uncertainties in a proposition and the degree of risk may be computed in terms of probability of associated risks. It is possible to educe them to a manageable level but these cannot be wiped out altogether. In short, we cannot think of a zero- risk situation, whether in our work environment or in our personal lives. Risk taking is a deliberate action in the process of financial decisionmaking. The action results from an optimal choice made by the decision maker, which, in turns, emanates from a systematic analysis of the various alternatives available. Risk taking is a calculated decision and phases like outcome fate o come what may, etc., do not find a place in the process of risk assessment. Particularly the risks associated with credit decisions taken by a banker, inter-relationship between the various credit related risks, qualification of such risks, theoretical framework of risk and the extent of their applicability in actual business decisions. We will also discuss about the principles and guidelines laid down in this context, both by the BIS (Bank for INTRNATIONAL settlement, Switzerland) and RBI (Reserve Bank of India). The various steps in construction of risk assessment
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models will also be discussed which would enable us to prescribe benchmarks for the purpose of decision making in dispensing credit. Any activity involves risk, touching all spheres of life, both personal and business, Risk is pervasive condition of human existence. The term risk has a variety of meaning in business and everyday life. Traveling in a car, crossing the road, investing in financial instruments, launching a new product all involves risk. At its most gnarl level, risk is used to describe any situation where there is uncertainty about what outcome will occur. Although our instinctive understanding of concept of risk is clear enough, terms that have a simple meaning in everyday usage sometimes have a specialized connotation when used in particular field.
DEFINATION
There is no universal accepted definition of risk. The term risk is variously defined as a) The chance of loss, b) The possibility of loss, c) Uncertainty, d) The dispersion of actual from expected results or e) The probability of any outcome different from the on expected. The Basel committee has defined risk as the probability of the unexpected happening-the probability of suffering a loss. Prof. John Geiger has defined risk as an expression of the danger that the effective future outcome will deviate from the expected in a negative way.
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Vaughan & Vaughan defined risk as A condition in which there is a possibility of an adverse deviation from desired outcome that is expected or hoped for. The four letters comprising the word R I S K define its features. R = Rare (unexpected). I = incident (outcome). S = selection (identification). K = knocking (measuring, monitoring, controlling). RISK, therefore, needs to b looked at from four fundamental aspects: Identification Measurement Monitoring Control (including risk audit)
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RISK VS UNCERTAINITY
Uncertainty must be taken in a sense radically distinct from the familiar notion of Risk, from which it has never been properly separated, The term risk, as loosely used in everyday speech and in economic discussion, really covers two things which, functionally at least, in their causal; relations to be phenomena of economic organization, are categorically different. The essential fact is that risk means in some cases a quantity susceptible of measurement, while at other times it is something distinctly not of this character; and there are far-reaching and crucial differences in the bearings of phenomenon depending on which of which of the two is really present and operating. It will appear that a measurable uncertainty, or risk proper, as we shall use the term, is so far different from an immeasurable one that it is not in effect an uncertainty at all. We accordingly restrict the term uncertainty to cases of the non-quantities type.
TYPES OF RISKS
The risk profile of an organization may be reviewed from the following angles: A. BUSINESS RISK: I. capital risk. ii. Credit risk. iii. Market risk. iv. Liquidity risk V. business strategy and environment risk. vi. Operational risk. vii. Group risk.
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B. CONTROL RISK:
i. Internal controls. ii. Organization. iii. Management (including corporate governance). iv. Compliance. Both these types of risk, however, are linked to the three omnibus risk categories listed below: 1. 2. Credit risks. Market risks.
3. Organizational risks.
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CLASSIFICATION OF RISK
Different risks require different methods and approaches to deal with them.
Pure Vs. Speculative Risk

As per the outcome of an event, a risk can either be pure or speculative. Pure risk refers to those events whose effects cause either loss or no loss to the enterprise in all circumstances but no gain. The chances of making any profit from such risk occurrences are abysmally low. A few examples of pure risk are fire, theft, earthquake, death, accident, etc. In case of speculative risk, the outcome may result in either a loss or a profit to; the organization. Examples of speculative risk for an organization include reduction in the selling price of its product, increasing number of distribution outlets, merger with any other organization, etc. Thus most of the speculative risks are from within the organization and are business-related. Some speculative risks are optional. Investment in equity of another company is an option, and not mandatory. Hence the risk arising out of such decision is optional and avoidable if desired so. Usually an insurance company insures pure risks but not speculative risks.
Classification of Pure Risks

There are four broad categories of pure risk. They are Property risk Personal risk Liability risk Loss of income risk.
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Property Risk
In this case there is a fear of loss of property because of some unforeseen events. Property includes both movable and immovable assets. There are always chances of loss of house because of earthquake, heavy storm and other natural calamities. Similarly a severe damage to a personal computer may be caused because of repetitive power failure or low voltage. Property risk is further divided into two categories, namely direct loss and indirect loss. The value of the property destroyed due to a given peril is a direct loss and the additional expenses incurred due to the destruction of the property are the indirect loss. Business establishment if there is loss to the stock because of fire, the company not only loses the stock but also the time to make up the pending supply orders. Chances are that it may lose some customers. This results in indirect loss to the business.
Personal Risk
It refers to the possibility of loss of income or assets as a result of the loss of the ability; to earn income. This may result from untimely death of the earning member, dependent old age, prolonged illness, disability or unemployment. Apart from individuals, organizations are also subject to personal loss exposures. When employees meet with accidents, it may result in injuries or death.
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Liability Risk
Liability risk arises when there is a possibility of an unintentional damage to other person or to his property because of negligence. However, the chances of intentional harm are not ruled out in certain circumstances. Legally speaking a person cannot be exonerated from his activities either intentional or unintentional, if it he same result in loss to some other person or his property. Thus there are always chances that liability risk is to be met because of ones activities causing adversity to another person. For example, construction of big dams results in dislocation of a number of villagers.
Loss of Income Risk

Loss of income risk is an indirect loss from a given risk. As discussed under property risks, whenever there is a direct loss, it is followed by some consequences that result in indirect loss. For example, if a textile companys premises were destroyed in an earthquake, the production facilities and plant layout are also disturbed and it would take some time to come back to the normal level of production. During this time the cost of production will tend to be high and the production stoppage will lead to loss of income. Some times the direct loss will be minimum but the indirect losses will be quite high. For instance, consider the plight of an Internet service provider where, an electrical short circuit resulted in hard disk crash and loss of data.
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Dynamic vs. Static Risk

Static risk remains constant over an observed period of time. Risks remain static because the environments in which they exist are static. Dynamic risks arise from the changes that occur in an environment, which may be economic, social, technological, and political. Change in the environment creates risk and uncertainty about the future.
Fundamental vs. Particular Risks

Those risks, which affect a larger group, such as a society or an industry, or a particular segment of an industry, are termed as fundamental risks. For example, natural calamities such as flood, earthquake, drought, epidemics, etc. affect the whole mass in the same manner irrespective of caste, creed or religion or geographical boundaries.
Attitude towards Risk

Attitude towards risk reflects the perception or a mental position with regard to a fact or state, or it is a feeling or emotion towards a fact or a situation. Individuals can be grouped into three different categories as per their attitude towards risk. They are: Those who are neutral/indifferent to risk, Those who are willing to take up risks, and Those who avoid risk.
Human Response to Risk

It is not possible for an individual or an organization to avoid risk. Every organization is exposed to risks of various degrees in the course of business. It is the
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duty of the risk manager of a company to analyze the characteristics of risks to which the organization is exposed and develop suitable strategies to minimize the same. Mankind has developed various tools and techniques to safeguard itself against the perceived risks and hazards since the dawn of civilization. Though the procedures or methods adopted for the purpose might have undergone a sea change, the objective remains the same. As the saying goes, Man proposes and God disposes, the uncertainty of outcome of any future event adds to the severity of risk in any situation.
OBJECTIVES OF THE STUDY

To study the methodology of risk analysis adopted by the company To understand the various risks involved in setting up an industrial project To study various measures for controlling the risk
METHODOLOGY
The format of the study was fixed after referring various books and reports from libraries and internet. It helped in identifying the approach needed for project work, research methods and report making. Sources of these literatures are mentioned in references.
Data collection
For the preparation of any project report the collection of relevant data is very much essential. There are basically two broad methods for collecting data, which are followed in any report. These methods are:
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Primary data collection. Secondary data collection. The sources of secondary data are: Printed or published financial
statements of the corporation, Annual reports of the company.
Limitations of the study

The study is conducted for the purpose of fulfillment of the conditions stipulated by the University for Completion of course, so the study may not fulfill all the requirements of a detailed investigation. As I am learner, I may not be able to provide a proper findings and suggestions. Time was a major constraint for knowing the entire process in depth..
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CHAPTER II
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PROFILE OF THE COMPANY
Dr. Reddys Laboratories Ltd. Founded in 1984 by Dr. K. Anji Reddy, has become Indias third biggest pharmaceutical company. Reddy had worked in the publicly-owned Indian Drugs and Pharmaceuticals Ltd. Reddy's manufactures and markets a wide range of pharmaceuticals in India and overseas. The company more than 190 medications ready for patients to take, 60 active pharmaceutical ingredients, for drug manufacture, diagnostic kits, critical care and biotechnology products. Reddys began as a supplier to Indian drug manufacturers, but it soon started exporting to other less-regulated markets that had the advantage of not spend time and money on a manufacturing plant that that would gain approval from a drug licensing body such as the USs Food and Drug Administration. Much of Reddys early success came in those unregulated markets, where process patents not product patents are recognized. With that money in the bank, the company could reverseengineer patented drugs from more developed countries and sells them royalty-free in India and Russia. By the early 1990s, the expanded scale and profitability from these unregulated markets enabled the company to begin focusing on getting approval from drug regulators for their formulations and bulk drug manufacturing plants in moredeveloped economies. This allowed their movement into regulated markets such as the US and Europe. By 2009, Reddys had six FDA-plants producing active pharmaceutical ingredients in India and seven FDA-inspected and ISO 9001 (quality) and ISO 14001 (environmental management) certified plants making patient-ready medications five of them in India and two in the UK. By 2010 Dr. Reddys Q3 FY09 Revenue at Rs. 18,401 million,EBITDA at Rs. 3,453 million, PAT at Rs. 1,924 million
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By 2010 Dr. Reddys Q3 FY10 Financial Results: Revenues at Rs. 17,296 million; EBITDA at Rs. 3,666 million, Profits after Tax adjusted for impairment at Rs. 2,307 million.
ABOUT DR.REDDYS
Established in 1984, Dr. Reddy's Laboratories (NYSE: RDY) is an emerging global pharmaceutical company with proven research capabilities. The Company is vertically integrated with a presence across the pharmaceutical value chain. It produces finished dosage forms, active pharmaceutical ingredients and biotechnology products and markets them globally, with focus on India, US, Europe and Russia. The Company conducts research in the areas of diabetes, cardiovascular, anti-infectives, inflammation and cancer.
KEY MILESTONES
1984 Dr Anji Reddy establishes Dr. Reddy's Laboratories with an initial capital outlay of Rs.25 lakhs 1986

Dr. Reddys goes public Dr. Reddys listed on Bombay Stock Exchange (BSE) Dr. Reddys enters international markets with exports of Methyldopa
1987

Obtains its first USFDA approval for Ibuprofen API Starts its formulations operations
1988
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Acquires Benzex Laboratories Pvt. Limited to expand its Bulk Actives business.
1990 Dr. Reddys, for the first time in India, exports Norfloxacin and Ciprofloxacin to Europe and Far East. 1991 First formulation exports to Russia commence. 1993 Dr. Reddy's Research Foundation established. The company drug discovery programme starts. 1994

Makes a GDR issue of USD 48 million Foundation stone laid for a finished dosages facility to cater to the highly regulated markets such as the US.
1995 Sets up of a Joint Venture in Russia. 1997
Licenses anti-diabetic molecule, DRF 2593 (Balaglitazone), to Novo Nordisk. Becomes the first Indian pharmaceutical company to out-license an original molecule. First ANDA filed with the United States Food and Drug Administration for Ranitidine
1998 Licenses anti-diabetic molecule, DRF 2725 (Ragaglitazar), to Novo Nordisk
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1999 Acquisition of American Remedies Limited, a pharmaceutical company based in India. 2000

Dr. Reddy's Laboratories becomes India's third largest pharmaceutical company with the merger of Cheminor Drugs Limited, a group company Reddy US Therapeutics, a wholly-owned subsidiary, is established at Atlanta, US to conduct target based drug discovery
2001
Becomes the first Asia Pacific pharmaceutical company, outside Japan, to list on the New York Stock Exchange. Listed with the symbol RDY on April 11, 2001. Out-licenses DRF 4158 to Novartis for up to US $55 million upfront payment Launches its first generic product, Ranitidine, in the US market Becomes the first Indian pharmaceutical company to obtain an 180-day exclusive marketing rights for a generic drug in the US market with the launch of Fluoxetine 40 mg capsules on August 3, 2001
2002 Conducts its first overseas acquisition BMS Laboratories Limited and Meridian Healthcare in UK3 2003

Announces a 15-year exclusive product development and marketing agreement for OTC drugs with Leiner Health Products in the US Launches Ibuprofen, first generic product to be marketed under the Dr. Reddys label in the US
2004 Acquires Trigenesis gives access to drug delivery technology platforms
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2006
Acquires Roche's API Business at the state-of-the-art manufacturing site in Mexico with a total investment of USD 59 million. announces the formation of Perlecan Pharma: Indias First Integrated Drug Development Company. Announces India's first major co-development and commercialization deal for its molecule Balaglitazone (DRF 2593), with Rheoscience. announces a unique partnership for the commercialization of ANDAs with ICICI Venture.
2009 Revenues touch USD 1 Billion in December 2009. Dr. Reddy's obtains its second 180-day marketing exclusivity for a generic drug in the US market with the launch of Ondenesetron Hydrochloride Tablets. becomes an Authorized Generic Partner for Mercks Proscar & Zocor in the US market during 180 day exclusivity period. Acquires betapharm- the fourth-largest generics company in Germany for a total enterprise value of 480 million. 2010 Becomes No.1 pharmaceutical company in India in turnover and profitability. 2010 Announces strategic alliance with GlaxoSmithKline plc to develop and market select products across emerging markets outside India.
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CORPORATE GOVERNANCE
Dr. Reddy's long-standing commitment to high standards of corporate governance and ethical business practices is a fundamental shared value of its Board of Directors, management and employees. The Company's philosophy of corporate governance stems from its belief that timely disclosures, transparent accounting policies, and a strong and independent Board go a long way in preserving shareholder trust while maximizing long-term shareholder value. The company has identified and articulated its core purpose, mission and values in keeping with its desire for achieving corporate excellence. Dr. Reddy's believes in creating an environment where the parameters of conduct and behavior of the company and its management is constantly aligned with the business environment. The mainstays of Dr. Reddy's Corporate Governance systems are an independent Board of Directors following international practices, a committed management team, rigorous internal control systems and the transparent dissemination of information to stakeholders. Committees of the Board Committees appointed by the Board focus on specific areas and take informed decisions within the framework of delegated authority, and make specific recommendations to the board on matters in their areas or purview. All decisions and recommendations of the committees are placed before the Board for information or for approval.
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Dr. Reddy's has seven Board-level Committees, namely

The Audit Committee The Compensation Committee The Governance Committee The Shareholders' Grievance Committee The Investment Committee The Management Committee
The members of the Committees of Board are as under: Audit Committee Dr. Omkar Goswami (Chairman) Kalpana Morparia Ravi Bhoothalingam Compensation Committee Ravi Bhoothalingam (Chairman) Kalpana Morparia P N Devarajan Dr. JP Moreau Governance Committee Anupam Puri (Chairman) Prof. Krishna G Palepu Dr. Omkar Goswami Management Committee Satish Reddy (Chairman) G V Prasad P N Devarajan Investment Committee G V Prasad (Chairman) Satish Reddy P N Devarajan Shareholders' Grievance Committee P N Devarajan (Chairman) G V Prasad Satish Reddy
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AWARDS AND ACCOLADE

The Appreciation Certificate of the District Collector for being the Best Clean Production Industry for the year 2010 was awarded to API Unit V. The CII Southern Region Leadership Excellence Award was awarded to Dr. Reddy's for the year 2009. The CII National Award for Excellence in Water Management for the year 2005 was awarded to both API Units II and VI. The FTO III Unit of Dr. Reddy's achieved the ISO 14001:2004 standard on June 9, 2005. The Genentech Environmental Excellence Silver Award for the year 2004-05 was awarded to the API Global Business Unit.
KEY PERSONS
1. Mr.Dr.K.ANJI REDDY CHAIRMAN 2. Mr.G.V.PRASAD VICE CHAIRMAN & C.E.O 3. Mr.SATISH REDDY M.D & C.O.O 4. Mr.Dr.OMKAR GOUSWAMI 5. Mr.RAVI BHOOTHALINGAM 6. Mr Dr.KRISHNA PALEPU 7. Ms.KALPANA MORPARIA
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8. Mr.J.P.MORE
OTHER OBJECTS:
1. To carry on the business of Distributors, Dealers, Wholesalers, Retailers, Commission Agents, Manufacturers, Representatives for all types of products. 2. To carry on the business of professionals for all types of services. 3. To carry on the business of design, engineering and execution and implementation of various Types of projects on contract or turnkey basis and to acquire the designing or technical know how. 4. To cultivate, grow, produce or deal in any vegetable products and to carry on the business of Farmers, dairy man, milk contractors, dairy farmers, millers, surveyors and vendors of milk cream, Cheese, butter and poultry and provision of all kinds, growers of and dealers in corn, lay and Straw, seeds men and nursery men and to buy, sell and trade in any goods usually traded and of The above business or other business associated with the farming interest which may be Advantageously carried on by the company. 5. To carry on the business of manufacturers, fabricators, erectors, dealers of in all types of Chemical equipment, pumps, valves, storage tanks etc. required by the chemical and Pharmaceutical industry.
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6. To purchase plant, machinery, tools and implements from time to time and he selling or disposing of the same.
7. To transact or carry on all kinds of agency business and in particular, in relation to the investment of money, the sale of property and collection and receipt of money, or otherwise of any assets, funds and business under any agreement. 8. To carry on and undertake the business of investing its funds in equity and preference shares, stocks, bonds, debentures (convertible and nonconvertible) of new projects and securities of all kinds and every description of well established and sound companies, to subscribe to capital issues of joint stock companies, ventures, industries, units, trading concerns whether old or new as the company my think fit and to assist them by granting financial accommodation by way of loans/advances to industrial concerns and to assist industrial enterprises in creation , expansion and modernization upon terms whatsoever and to act as finance brokers, merchants and commission agents and to deal in Govt. Securities including Govt. bonds, loans, National savings Certificates, post office saving schemes, units of investments etc., include units of Unit Trust of India. 9. To promote industrial finance, deposit or lend money, securities and properties to or with any company, body corporate, firm person or association whether falling under the same management otherwise, in accordance with and to the extent permissible under the provisionscontained in Section 370&372 of the, Companies Act, 1956, with or without security and on such Terms as may be determined from time to time. However, the company shall not carry on the business of Banking as defined under the Banking
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Regulation Act. 1949; and to carry on and undertake the business of finance, investment and trading, hire purchase, leasing and to finance lease operations of all kinds, purchasing, selling, hiring or letting on hire of all kinds of plant and machinery and equipment that the Company may think fit and to assist in financing operations of all and every kind of description of hire purchase or deferred payment or similar transactions and to subsidies finance or assist in subsidizing or financing the sale and maintenance of any goods, articles or commodities of all and every kind of description upon any terms whatsoever and to purchase or otherwise deal in all forms of immovable and movable property, including lands and buildings, plant and machinery, equipment, ships, aircraft, automobiles computers and all consumer, commercial and industrial items and to lease or otherwise deal with them in any manner whatsoever including release there of regardless of whether the property purchased and leased be now and /or used.
10. To provide a package of investment/merchant banking services by acting as manages to public issue securities, by underwriting securities, act as Issue House and to carry on the business of registrars to investment schemes, Money managers to secure and extend market support by conducting surveys, collecting data, information and reports and to act as general traders and Agents, to carry on the agency business and warehousing indenting and dealership of business. IV. The liability of the members of the company is limited. V. a. The authorized share capital of the company is Rs.50,00,00,000/- (Rs. Fifty Crores Only)divided into 10,00,00,000 equity shares of Rs.5/- (Rs. Five only) each.
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b. The company has power from time to issue shares, Hybrids, Derivatives, Options, Quasiequity Instruments, with differential rights, or to increase, consolidate, sub-divide, exchange,reduce and also to purchase any of its shares whether or not redeemable and to make payments out of its capital in respect of such purchase or otherwise alter its share capital as equity or non voting equity shares or preference shares and to attach to any classes of such shares preferences, rights, privileges or priorities in payment of dividends or distribution of assets or otherwise, over any other shares and to subject the same to any restriction, limitation or condition and to vary the regulation of the company, as for apportioning the right to participate in profits in any manner subject to the provision of the Act and consent of the appropriate authorities if required, being obtained before doing so. We the several persons whose names, addresses and description are subscribed hereto are desirous of being formed into a company in pursuance of the Memorandum of Association and we respectively agree to take the number of shares in the Capital of the Company set opposite to our respective names.
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CHAPTER III
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RISK MANAGEMENT:
Risk management is a scientific approach applied to the problem of risk. Although the term risk management is a recent phenomenon, the actual practice of risk management is as old as civilization itself. Risk management allows financial institutions to bring their risk leels to manageable proportions while not severely reducing innovative their income. Factors like increasing competition, changing products, technological revolution, and
external operating environment makes it necessary that proper risk management systems b implemented, Risk management is thus a functional necessity and adds to the strength and efficiency of an organization on an ongoing basis.
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Risk Management Techniques:

Risk management is a structured approach to managing uncertainty through, risk assessment, developing strategies to manage it, and mitigation of risk using managerial resources. The strategies include transferring the risk to another party, avoiding the risk, reducing the negative effect of the risk, and accepting some or all of the consequences of a particular risk. Some traditional risk managements are focused on risks stemming from physical or legal causes (e.g. natural disasters or fires, accidents, death and lawsuits). Financial risk management, on the other hand, focuses on risks that can be managed using traded financial instruments. Objective of risk management is to reduce different risks related to a preselected domain to the level accepted by society. On the other hand it involves all means available for humans, or in particular, for a risk management entity (person, staff)
Steps in the risk management process Establish the context

Establishing the context involves 1. Identification of risk in a selected domain of interest 2. Planning the remainder of the process. 3. Mapping out the following:
o o o
the social scope of risk management the identity and objectives of stakeholders The basis upon which risks will be evaluated, constraints.
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4. Defining a framework for the activity and an agenda for identification. 5. Developing an analysis of risks involved in the process. 6. Mitigation of risks using available technological, human and organizational resources.
Identification
After establishing the context, the next step in the process of managing risk is to identify potential risks. Risks are about events that, when triggered, cause problems. Hence, risk identification can start with the source of problems, or with the problem itself. Source analysis Risk sources may be internal or external to the system that is the target of risk management. Examples of risk sources are: stakeholders of a project, employees of a company or the weather over an airport.
Problem analysis Risks are related to identify threats. For example: the threat of losing money, the threat of abuse of privacy information or the threat of accidents and casualties. The threats may exist with various entities, most important with shareholders, customers and legislative bodies such as the government. Resources and consider the threats they are exposed to and the consequences of each. Alternatively one can start with the threats and examine which resources they would affect, or one can begin with the consequences and determine which combination of threats and resources would be involved to bring them about.
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Assessment
Once risks have been identified, they must then be assessed as to their potential severity of loss and to the probability of occurrence. These quantities can be either simple to measure, in the case of the value of a lost building, or impossible to know for sure in the case of the probability of an unlikely event occurring. Therefore, in the assessment process it is critical to make the best educated guesses possible in order to properly prioritize the implementation of the risk management plan. The fundamental difficulty in risk assessment is determining the rate of occurrence since statistical information is not available on all kinds of past incidents. Furthermore, evaluating the severity of the consequences (impact) is often quite difficult for immaterial assets. Asset valuation is another question that needs to be addressed. Thus, best educated opinions and available statistics are the primary sources of information. Nevertheless, risk assessment should produce such information for the management of the organization. That the primary risks are easy to understand and that the risk management decisions may be prioritized. Thus, there have been several theories and attempts to quantify risks. Numerous different risk formulae exist, but perhaps the most widely accepted formula for risk quantification is: Rate of occurrence multiplied by the impact of the event equals risk Later research has shown that the financial benefits of risk management are less dependent on the formula used but are more dependent on the frequency and how risk assessment is performed.
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In business it is imperative to be able to present the findings of risk assessments in financial terms. Robert Courtney Jr. (IBM, 1970) proposed a formula for presenting risks in financial terms. The Courtney formula was accepted as the official risk analysis method for the US governmental agencies. The formula proposes calculation of ALE (annualized loss expectancy) and compares the expected loss value to the security control implementation costs (cost-benefit analysis).
The Effect of Risk

As mentioned earlier risk results in gains or losses. If we invest in an equality share we may gain or lose when we sell it at a later date. If a fire accident occurs in a warehouse it will result in losses only. We are very much concerned with negative impact of risk when we attempt to manage it. Loss is a state wherein someone is deprived of something he/she had. When we attempt to assess the risk, it is important to know from whose point of view the risk is being assessed. It can be perceived from the point of view of the insurer or the insured from the point of view of an insurance agency risk may be perceived fro the purpose of assessing the degree of vulnerability of a particular object to a particular event.
Potential risk treatments

Once risks have been identified and assessed, all techniques to manage the risk fall into one or more of these four major categories: (Dorfman, 1997) Avoidance (elimination) Reduction (mitigation) Retention Transfer ( buying insurance)
Risk avoidance:
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Includes not performing an activity that could carry risk. An example would be not buying a property or business in order to not take on the liability that comes with it. Another would be not flying in order to not take the risk that the airplane were to be hijacked. Avoidance may seem the answer to all risks, but avoiding risks also means losing out on the potential gain that accepting (retaining) the risk may have allowed. Not entering a business to avoid the risk of loss also avoids the possibility of earning profits. Risk Reduction. Involves methods that reduce the severity of the loss or the risk of the loss from occurring. Examples include sprinklers designed to put out a fire to reduce the risk of loss by fire. This method may cause a greater loss by water damage and therefore may not be suitable. Halon fire suppression systems may mitigate that risk, but the cost may be prohibitive as a strategy. Modern software development methodologies reduce risk by developing and delivering software incrementally. Early methodologies suffered from the fact that they only delivered software in the final phase of development; any problems encountered in earlier phases meant costly rework and often jeopardized the whole project. By developing in iterations, software projects can limit effort wasted to a single iteration. Outsourcing could be an example of risk reduction if the outsource can demonstrate higher capability at managing or reducing risks. In this case companies outsource only some of their departmental needs. For example, a company may outsource only its software development, the manufacturing of hard goods, or customer support needs to another company, while handling the business management itself. This way, the company can concentrate more on business development without having to worry as much about the manufacturing process, managing the development team, or finding a physical location for a call center.
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Risk retention:
Involves accepting the loss when it occurs. True self insurance falls in this category. Risk retention is a viable strategy for small risks where the cost of insuring against the risk would be greater over time than the total losses sustained. All risks that are not avoided or transferred are retained by default. This includes risks that are so large or catastrophic that they either cannot be insured against or the premiums would be infeasible. War is an example since most property and risks are not insured against war, so the loss attributed by war is retained by the insured. Also any amounts of potential loss (risk) over the amount insured are retained risk. This may also be acceptable if the chance of a very large loss is small or if the cost to insure for greater coverage amounts is so great it would hinder the goals of the organization too much.
Risk transfer:
Means causing another party to accept the risk, typically by contract or by hedging. Insurance is one type of risk transfer that uses contracts. Other times it may involve contract language that transfers a risk to another party without the payment of an insurance premium. Liability among construction or other contractors is very often transferred this way. On the other hand, taking offsetting positions in derivatives is typically how firms use hedging to financially manage risk. Some ways of managing risk fall into multiple categories. Risk retention pools are technically retaining the risk for the group, but spreading it over the whole group involves transfer among individual members of the group. This is different from traditional insurance, in that no premium is exchanged between members of the group up front, but instead losses are assessed to all members of the group.
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RISK MANAGEMENT ESSENTIALS

After reading this chapter, you will be conversant with The nature of risk management The evolution of risk management Risk in personal life Corporate/organizational risks The process of risk management
Nature of Risk Management

Risk management aims to at controlling the risk exposure of a firm. It is a rational approach towards controlling the risk to which an organization or an individual is exposed to; risk management function can be grouped with other management functions such as financial management, human resources management, etc. An over view of different risks will help us to understand the nature of risk management organizations and individuals are exposed to a wide arrays of risk in their day-to-day operations, such as 1 2 3 4 5 6 7 8 9 10 Fire risk Risk of theft Loss of customers Delay in delivery of raw materials Break down of machinery Accidents Bad debts Changes in industrial policy whenever the government changes Changes in financial markets Changes in taxation etc.
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The perspective of risks management varies from one individual. Organizations have their own views on risk. Many scholars and practitioners Agree that risk management is an evolving science while a distinct minority feels that it is going to disappear in the years to come. In between there are many views on the nature of risk management. The traditional view of risk management, believes that risk management is an interdisciplinary science that manages that pure risk of an organization. According to this view risk management is not changing radically but moving in increments, there fore it is an evolving science. This view recommends insurance purchase as a risk management solution.
1 2 3 4
Hardware Software failure Organization failure Human failure
Development of Risk Management

Risk management as discussed earlier is Avery old method through which the organization aims to cover the perils to which the organization is exposed. The most popular method advocated by traditional view was buying insurance. In 1929, the corporate insurance buyers met and started discussing various problems of mutual interest. Though the meeting was not a formal one, it was a precursor to orient corporate thinking and deal with risk in a more systematic way. In 1931, the American management association established an insurance division. The primary objective of the division was to provide a platform for discussing about risk management and publish news and views of the members. This helped in creating awareness among the various risk managers about the existence of a systematic wing
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for managing the risk. National insurance buyers association was started in America, which was later renamed as risk insurance management society (RIMS). Though risk management penetrated deep in the world business as a form of insurance, it had yet to carve a niche in the world of personal insurance, as the individual risk management awareness arrived at a later stage of the growth of the risk management. It is difficult to say whether the growth in risk management can be attributed to the growth in business practices. But it can be said that the development of present day risk management activities stem from the development which took place during early 1950s. Risk management practices were in vogue prior to this period, but they were not universally popular. In other ways the different countries were having different sets of underlying principles, philosophy and strategies to manage the risk management.
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Maturity of the risk management. Ability and knowledge of risk manager. Types of organization. During the earlier period, management was developed as an independent
function of management, as most of the organization perceived it as an offshoot of financial management. This may be because of the conversion and measurement of risk, which in turn resulted in underwriting of insurance policies in financial terms, as was the case of the hierarchy of the risk manager in the organization. Previously, risk managers were either working under the finance department of purchase department.
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Reliability movement of the 1950s System safety movement of the 1960s and the 1970s
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He illustrated how the concepts of safety management were well adopted in risk management. He implied this way of risk management to be more inclined towards the financial side of risk management. The practice of risk management in Indians public sector is ever three decades old. The reasons for late recognition of the importance of risk management are many. In India government organization are immune to different types of legal liability and the effect of any other exposures can be passed on to the government. Thus, the risk management principles were not much popular in government organizations. But as the completive forces of the market forced the government to shed the primitive practices and rules, they have become more conscious and started to imbibe risk management practice. There are various constraints in the implementation of risk management function. Some of them are. A. B. C. D. E. Size of the organization Decentralization of authority Democratization of decision making Multiple objectives Administration complexities, etc.
Corporate Risk Management

Private corporate sector adopted active risk management for a variety of reasons. The risk management program of a corporate entity aims at logical way to solve problems it perceives. These problems if not managed properly, can result in heavy losses. The loss may be in term of money, material, opportunities or human life. 1. The risk manager of a company develops plans for protecting against any unfavorable events. He undertakes the risk management process, whish starts from information, supervising the initiation and progress plans of loss control measures, which are critical for the organization. He also undertakes
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negotiation for the terms and conditions to cover the losses and takes adequate steps for amicably setting them against the insurers. There are few activities involving risks, which still remain with in the organization even when no insurance has been undertaken. What are the various activities or circumstances, which can cause loss to the organization? 2. What are the alternatives available to the organization to protect it self against these activities and circumstances?
TYPES OF RISK BUSINESS RISKS

By definition, business risks includes all risk factors, whether it affects a business directly (loss affecting capital etc.) or indirectly (continued loss affecting business strategy). Business risk can be divided into following:
i. Capital risk:
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The size of the owners stake (like capital) in the organization determines the strength of its operation. The composition of its capital- Tier-I (paidup capital + reserves) and Tier-II (bonds, hybrid instruments etc.)-depends on its resource mobilization capacity. If an organization can access capital from only limited sources like directors (their friends and relatives) rather than from the public, then this may act as a constraint on capital. In contemporary financial management, capital has a number of components. These include: Accounting capital: funds belonging to the promoters/owners. Regulatory capital: the minimum amount of capital necessary to take care of asset value as per regulatory requirements Economic capital: the amount of amounts of funds set aside to absorb any violent unexpected loss. According to the Basel committee, capital base is one of the three pillars of risk assessment (the other two being supervisory role and market discipline).
ii. Credit risk:

While we will discuss comprehensively on this category of risk in subsequent chapters, it may be sufficient at this stage to indicate its components: Credit growth in the organization and composition of the credit folio in terms of sectors, centers and size of borrowing activities So as to assess the extent of credit concentration. Credit quality in terms of standard, sub-standards, doubtful and loss-making assets. Extent of the provisions made towards poor quality credits.
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Volume of off-balance-sheet exposures having a bearing on the credit portfolio.
iii. Market risk:

The components of this risk type are: Composition of the investment portfolio. Quality of the investment portfolio (i.e., investment in rated and unrated instruments). Interest rate volatility and sensibility. Where in a business the foreign exchange aspect is also vital (i.e., banking/export oriented units). Equity/commodity risk (i.e., hedged/unhedged component).
iv. Earnings risk:

This covers a host of items such as: Budget and profit planning function in the organization. Analysis of income/expenses (with a focus on interest and non-interest income in case of banks/financial institutions). Earnings quality and stability.
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v. Liquidity risk:
Covers areas such as: Composition (wholesale/retail deposits in the case of banks with geographical and classification of depositors etc.). Liquidity profile (mismatch between term and non-term liabilities, behavioral maturity profile, diversification of funding sources etc.)
vi. Business strategy and environment risk:

Covers the following areas: External environment and macro-economic factors. Strategy with regards to market share, geographical spread, compatibility of strategy with in-house experience and expertise. Business profile analysis using SWOT (strength, weaknesses, Opportunities and threats), strength of competitors, scope and diversification, extent of customer loyalty etc. Strategy business initiatives on the institution and streamlining of business development and proactive measures taken. Experience and skills of key personnel in the organization and success in planning. Adequacy and compatibility of IT system and business needs.
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vii. Operational risk:

This really is an omnibus type of risk as it covers the entire gamut of activities in an organization. The main components of operational risk are: People risk: the capabilities, competence and motives of the people in the organization. Technology risk: system failure, system security, back-up and disaster recovery plans, IT- related frauds etc. Legal risk: documentation for transactions, security, compliance with customer confidentiality etc. Reputation risk: perception of customers and stakeholders of the organization, regulatory perception process, strength for transaction delivery etc. Operating environment: abrupt non-macro economic changes in the organization.
viii. Group risk factors:

These include Capital concentration of the parent/group, gearing of capital, return on capital, investment, relationship with subsidiaries, commonality of interest. Operating and financial performance of the subsidiaries, shares of business and competition faced by subsidiaries. Contagious problems overlooked by the parent organization.
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Risks arising from connected lending and intra-group exposures, risks from joint ventures, etc. Compliance by subsidiaries with regulatory guidelines in the area of operation.
CONTROL RISKS
In the entire risk measurement process, control of activities finds a prominent place. A control mechanism is a must for any organizations well-being. Control risks can be divided into:
I. internal control risk:

Lack of a clear line of responsibility and authority. In-house lack of control may lead to housekeeping and other problems, which may affect the organizations well-being. Poor system for monitoring and reporting suspicious transactions that have a noticeable impact on the organization. No regular surveillance of the control mechanism by the top management.
ii. Organizational risk:

Vague and overlapping organizational structure with unclear legal implications. Absence of a structured assessment mechanism to leverage external and internal relationship. Absence of a cordial industrial relationship. Lack of an adequate support system to evaluate major customer relationships.
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iii. Management (including corporate governance) risk:

Composition, cohesiveness, competence and leadership attributes of the board of directors. The match between the board and the organizations risk philosophy and risk appetite. Non-assessment of the effectiveness of control functions of senior management. Absence of a clear succession planning mechanism. Undefined responsibility and accountability. Whether it follow contemporary corporate governance practices, especially with regards to strategy formulation and problem-solving.
iv. Risk from the compliance angle:

Necessary emphasis not accorded to compliance with guidelines laid down by the regulatory authorities. Deviations not reported to the competent authorities when they arise. Non-adherence to a monitorable action plan (MAP), if any, prescribed by a competent authority.
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It is evident that all these risks are interlinked. For example, the credit risk of a bank may emerge from operational risk, where the default is the result of fraudulent activity by the banks staff/others or lack of care on their part. Ultimately it is reflected in the organizations earnings (for example, losses due to credit risk, market risk and operational risk) and capital. As omnibus categories, credit risk, market risk and operational risk cover all items of business risk and control risk. This is precisely why, internationally, risk analysis is done on these three types only
RISK MANAGEMENT TECHNIQUES

It is aptly said that: Risks do not disappear, they give users a choice; which to retain and which to shed. There is no escape from the presence of risk, and humanity must accordingly seek ways of dealing with it. Some risk-generally of a fundamental nature-are met through the collective efforts of society and government. Police and fire departments are good examples of the collectively financial approaches to dealing with risk. The existence of risk is a source of discomfort to most people, and the uncertainty accompanying it causes anxiety and worry. Since risk is distasteful and unpleasant, peoples rational nature leads them to attempt to do something about it. Basically, people deal with risk in five ways. They avoid, retain, transfer, share and reduce it.
Avoidance:
Risk is avoided when the individual refuses to accept the risk even for an instant. This is accomplished by merely not engaging in the action that gives rise to risk. If you want to avoid the risks associated with the ownership of property, do not purchase the property, but lease or rent it instead. The
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avoidance of risk is a method of dealing with risk, which is a negative rather than a positive technique. Personal advancement of the individual and progress in the economy both require risk taking. If risk avoidance were utilized extensively, both the individual and society would suffer. For this reason, avoidance is an unsatisfactory approach to dealing with risks.
Retention:
Risk retention is perhaps the most common method of dealing with risk. An individual faces an almost unlimited array of risks; in most cases nothing is done about them. When an individual does not take positive action to avoid, reduce, and transfer the risk, the possibility of loss involved in that risk is retained. As a general rule, risks that should be retained are those that lead to relatively small losses.
Transfer:
Risk may be transferred from one individual to another who is more willing to bear the risk. An example is the process of hedging, where an individual guards against the risk of price changes in one asset by buying or selling another asset whose price changes in an offsetting direction. For example, futures markets have been created to allow farmers to protect themselves against changes in the price of their crop between planting and harvesting. A farmer sells a futures contract, which is actually a promise to deliver at a fixed price in the future. If the value of the farmers crop declines, the value of the farmers future position goes up to offset the loss. Insurance is also a means of shifting or transferring risk. In consideration of a specific payment (the premium) by one party, the second party contracts to indemnify the first party unto a certain limit for the specified loss that may or may not occur.
Sharing:
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Risk is shared when there is some type of arrangement to share losses. Risks are shared in a number of ways in our society. Under the corporation form of business, the investments of a large number of persons are pooled. A large number of investors may pool their capital, each bearing only a portion of the risk that the enterprise may fail. Insurance is another device designed to deal with risk through sharing, (Sharing is a form of transfer, in which the risk of the individual is transferred to a group. In addition, it may be viewed as a form of retention. In which the risks of a number of individuals are retained collectively).
Reduction:
Risk may be reduced in two ways i.e., through loss prevention and control. There is almost no source of loss where some efforts are not made to avert the loss. Safety programs and loss prevention measures, such as Medicare, fire departments, security guards, burglar alarms are examples of attempts to deal with risk by preventing the loss or reducing the chance that it will occur.
RISK MANAGEMENT PROCESS

Risk management activities occur before, during, and after losses. Most planning is done before losses occur. Losses involving natural disasters and other emergencies also require action while losses are happening. After the loss, the risk manager must file insurance claims and analyze loss patterns. Establishing risk management objectives, tolerances and limits for all of the enterprise's significant risks
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Assessing risks within the context of established tolerances Developing cost-effective risk management strategies and processes consistent with the overall goals and objectives Implementing risk management processes Monitoring and reporting upon the performance of risk management processes Improving risk management processes continuously Ensuring adequate communication and information for decision making
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SOURCES OF RISK
Source of risk can b classified in several ways. Source of risk that arises from the ownership of property: physical (e.g., fire), social (riot), and economic (inflation).
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However, since the risk at hand is the identification of all types of risk, possible sources of risk must b constructed broadly. For instance, the following sources of risk represent on listing:
Physical environment Social environment Political environment Legal environment Operational environment Economic environment Cognitive environment PHYSICAL ENVIRONMENT:
The physical environment is fundamental source of risk. Earthquakes, drought, or excessive rainfall can all lads to loss. The ability to fully understand our environment and the effects we have on its as well as those it has on us is a control aspect of this source of risk. The physical environment may b the source of risk. The physical environment may both source of opportunity as well, for example, real stat as an investment, agribusiness, and with as a contributing factor to tourism.
SOCIAL ENVIRONMENT:
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Changing morals and values, human behavior, social structures, and institutions are a second source of risk. Many American business executives become frustrated when thy move into the international domain. For example, differing social values and norms in Japan have proven to be a particular source of uncertainly for American and European business managers. Within the underscores the important of this source of risk. Changing culture values also create opportunities, as when new attitudes regarding women in the workforce open a door to a significant talent pool.
POLITICAL ENVIRONMENT:
Within a single country, the political environment cans b an important source of risk. A new president can move the nation into a policy direction that might have dramatic effects on particular organizations (cuts in aid to local governments, new stringent regulation on toxic waste disposal). In the international realm, the political environment is even more complex. Not all nations are democratic in their form of government, and politics towards business. Foreign assts might b confiscated by a host government o tax policies might change dramatically. The political environment also can promote positive opportunities though fiscal and monetary policy, enforcement of laws.
LEGAL ENVIRONMENT:
Within the United States today, a gat deal of uncertainty and risk arises from the legal system. Not only are standards of conduct upheld and punishments enforced, but as the system itself evolves new standards arise may that not b fully anticipated. In the international domain, complexity increases because legal standards can vary from country to country. The legal environment also produces positive outcomes in
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the sense that rights are protected and that the legal system provides a stabilizing influences on society.
OPRATIONAL ENVIRONEMNT:
Processes and procedures of an organization generate risk and uncertainty. A formal procedure for promoting, hiring, or firing employees may generate a legal liability. The manufacturing process may put employees at risk of physical harm. Activities of an organization may result in ham to the environment. International business may suffer from risk or uncertainty due to unreliable transportation systems. The operational environment also provides gains, as it is the ultimate source of the goods and service by which an organization succeeds or fails.
ECONOMIC ENVIRONMENT:
Although the economic environment often flows directly from the political realm, the dramatic expansion of the global market place has created an environment that is greater than any single government. Although a markets is beyond the reach of a single nation. Inflation, recession and depression are now elements of interdependent economic systems. On a local level, interest rates and credit policies can impose significant risk on an organization.
COGNITIVE ENVIRONMENT:
An important source of risk for organization is the difference between perception and reality. The cognitive environment is a challenging source of risk to identify and analyze. The analyst must contemplate such questions as How do we understand the effect of uncertainty on the organization? and How do we know whether perceived
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risk is real? An evaluation of the cognitive environment partly addresses the distinction between risk and uncertainty.
CHAPTER IV
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WHAT IS VAR?
Value-at-risk (VaR) is a quintile based method of risk assessment of a portfolio. Value-at risk is widely used by banks, securities firms, commodity merchants, energy merchants, and other trading organizations. Such firms could track their portfolios' market risk by using historical volatility as a risk metric. They might do so by calculating the historical volatility of their portfolio's market value over a rolling 100 trading days. However, the problem with doing this is that it would provide a retrospective indication of risk. The historical volatility would illustrate how risky the portfolio had been over the previous 100 days. It would say nothing about how much market risk the portfolio was taking today. For institutions to manage risk, they must know about risks while they are being taken. If a trader mishedges a portfolio, his employer needs to find out before a loss is incurred. Value at-risk gives institutions the ability to do so. Unlike retrospective risk metrics, such as historical volatility, value-at-risk is prospective. It quantifies market risk while it is being taken. Another reason for popularity of VaR estimates is that it summarizes in a single, easy to understand number the downside risk of an institution due to financial market variables. VaR can be intuitively defined as the worst loss over a target horizon with a given confidence level. It can be defined either as an absolute number or as a
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percentage of the portfolio value .Crucial for the determination of the extreme future market value, and hence for the VaR, is the distribution function of the return on market value. The portfolio value as of today is a known parameter. However, its future value in a given time horizon is unknown and is a random variable. It will have a probability distribution based on historical data or expected value of different market variables like interest rate, Forex, etc. One such distribution is as shown in Exhibit 3, where the present portfolio value is shown to be P0. With VaR, we summarize the portfolios market risk by reporting some parameter of this distribution. For Ex, if the above distribution is for daily portfolio value, then the VaR value in the above figure depicts the 95% quintile of the portfolios daily loss. By this we mean that, the maximum loss in a single period cant exceed this value with a confidence level of 95% i.e. the expected loss would not be more than this value in 19 out of 20 days. Or in other words, the portfolio is expected to lose more than this value in 1 out of 20 days.
Exhibit 3: The distribution function of the return on market value usually a

normal or lognormal distribution is assumed for the market return. However, a normal distribution is claimed to underestimate the probability in the tail and hence the VaR, as VaR deals with extreme market situations. Popular alternatives include GARCHtype of models to allow for time-varying volatility and the Student-t distribution, since it allows for more probability mass in the tail than the normal distribution. Equally important for VaR estimation is uncertainty in parameter values. Parameter uncertainty leads to uncertainty in the VaR estimates. And this uncertainty increases with models that try to incorporate complex tail behaviors. Hence there is a trade off between more complex tail behavior and uncertainty in the VaR estimate. There are different methods for VaR calculation. One thing to keep in mind is that the choice of methodology used to estimate VaR gives rise to very different
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results of the VaR and hence it is more important to identify which method is best suited for a given portfolio and the intended use. The different methods are: 1. Variance-Covariance method 2. Historical simulation 3. Constant maturity model 4. Monte Carlo simulation
VaR Variance-Covariance Method

In this method, the portfolio return is assumed to have normal probability distribution. The advantage of this assumption is that the model can be defined in its entirety in terms of only 2 parameters Mean and Standard deviation of the portfolio return. In this way, this method is parametric in nature. The expected value of the portfolio is calculated as: Where 0E (1P) is the expected portfolio value in period 1 based on information in period 0.B is a column vector giving the weightage of different variables in the portfolio.is the mean vector of the variables in the portfolio. Similarly, standard deviation of the portfolio is defined as: Where: is the standard deviation for the portfolio. Is the covariance matrix of the portfolio, 1|0 indicating that the parameter is for period 1, and conditional on information available in period 0? B` is the transpose of vector b. One advantage of normal assumption is that quintiles of a normal distribution occur a fixed number (z) of standard deviations from the distributions mean which can be determined from standard normal distribution table. Since the computations are so modest, implementation of Variance-Covariance method runs in real time.
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However, it has the disadvantages associated with the normal distribution function. It ignores the distribution with fat tails and since VaR is more of a measure of tail distribution, normal assumption can lead to problem of overestimation or underestimation of VaR, thereby defeating the purpose of VaR estimation
Historical Simulation
This method is the simplest and most transparent method of calculation. This involves evaluating the current portfolio across a set of historical changes in the underlying variables to yield a distribution of changes in portfolio value, and computing VaR. The benefits of the method are its simplicity to implement, and the fact that it does not assume a normal distribution of asset returns. However, it requires a large database of historical values to be effective. Moreover, it assumes that the historical values are a good estimate for future values, which may not be always true.
Constant Maturity Model

In the Variance-Covariance method, the interaction between different variables underlying the portfolio has to be taken into account. This leads to multivariate models that include many parameters that are all estimated with uncertainty. This suggests that VaR-estimates for portfolios of securities are more uncertain. To avoid multivariate models, constant maturity value of the portfolio is determined at all times in history. The resulting time series of constant maturity values may be modeled in a univariate time series framework, which can be used to
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determine the VaR estimate for the constant maturity value of the portfolio. There is difference in the actual value and constant maturity value of a portfolio, however, over short forecasting horizons, this difference is negligible. An advantage of this approach is that it focuses on the portfolio return directly and not on Individual variable. Moreover, we can restrict ourselves to univariate models, which have the advantage of less parameter uncertainty than multivariate models, as the number of parameters to be estimated is less.
Monte Carlo Simulation

It is conceptually simple, but is generally computationally more intensive than the methods described above. In this method, some market model is used to generate random scenario of market variables for the pre-decided number of iterations. For each set, portfolio is revaluated and profit (loss) is calculated under the simulated scenario. These profits/losses are sorted in an order to give the simulated distribution and then this distribution is used to determine VaR at a particular confidence level. It is possible to compute an error term associated with the VaR estimate thus obtained and this error will reduce as the number of simulations increases. Monte Carlo Simulation is generally used to compute VaR for portfolios containing securities with non-linear returns. However, for a portfolio without these complex instruments, variance-covariance method is perfectly suitable and should be used. One thing should be kept in mind that Monte Carlo method is subjected to model risk if the model used is not very suitable. To determine which method is best suited for a given portfolio, the validity of the VaR Estimate should be carried out. This is generally done by back-testing. This is done through comparison of predicted and actual loss levels. This testing can also help in checking the assumptions, parameters and accuracy of the model. Another important
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aspect of VaR estimation is determination of time horizon and confidence level the popular values for time horizon are 1 day and 10 days. And for confidence level are 95% and 99%. We recommend the use of 1 day VaR with a confidence level of 99%. Time horizon of 1 day will help in monitoring daily mark-to-market changes in portfolio value and 99% confidence level would reduce the frequency of loss exceeding the VaR estimate.
ILLUSTRATION
In this section, the actual portfolio for the company taken as on 17th of May, 2010 is taken and then this portfolio is evaluated using market data since Apr 99 to determine VaR estimates with time horizon ranging from 1 day to 1 month and a confidence level of 95% and 99%. Valuation of Assets and Liabilities Below shows the exposure of the Company to various risk elements because of its Operation as well as treasury activities. Particulars Amount Exposure to Forex Exposure to Interest Rate Receivables USD 100 Millions Payables USD 10 Millions Loan EUR 400 Millions PCFC USD 154.5 Millions Adv (Falcon) USD 39 Millions Adv (Betapharma) EUR 26 Millions
Exhibit 4:
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Risk elements because of the company operation and treasury activities. Net Receivables Because of the predominantly export oriented business of the company, its Receivables in USD is greater than its Payables in USD and hence the difference is net receivables2. As explained earlier, because of a possible adverse forex market movement, the Company stands the risk of incurring a loss. Loan On 16th of February, 2009, the Company made the historic acquisition of Betapharma, 4th largest generic pharma company of Germany, for a huge sum of EUR 480,000,000. This acquisition has strategic importance because this will help the Company to get a strong 2 For the sake of simplicity; it is assumed that all the receivables and payables are only in USD. Although there are sales and purchases in other currencies as well, these are minor compared to USD transaction and hence this assumption is justified. 14 footholds in European market. However, for the acquisition, the Company had the take a massive long term loan of EUR 400,000,000 that is linked to the volatile 6 M EUR Libor rate. This loan is to be repaid within 5 years such that the average duration does not exceed 4 years. Because of this linkage and since the repayment of loan is to be made in EUR, the company is subjected to both interest rate and Forex risk. The terms of the loan are stated in Exhibit 5 below: Bank Amount (EUR) Resettlement Freq Interest Rate Duration Citibank 400,000,000 3 months 6 M EUR Libor rate + 150 basis points 5 Years
Exhibit 5:
Terms of the loan of EUR 400,000,000 for Betapharma acquisition since the interest rate is reset every 3 months, the market value of the loan amount is same as the book value on the date of reset. Hence, the valuation of the loan on any date is done as follows: Where:
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P = Book value of the loan CP = Interest rate (Reset every 3 months, 6 M EUR Libor rate + 150 basis points) DR = Discount rate (6 M EUR spot Libor rate + 150 basis points) D = Number of days from valuation date to next resettlement Z = Number of days between resettlements B = Interest basis (Taken 365 days) The Market value obtained is in EUR and to convert it to INR, it has to be multiplied with the EUR/INR exchange rate on the valuation date.
PCFC
Packing Credit Foreign Currency (PCFC) are short term loans taken by the Company for Meeting its working capital requirement. Exhibit 6 below shows the terms and details of the various PCFC loans taken by the Company.
P*(1+CP/4) (ZD)*CP
(1+DR/4) D/Z B Market Value =15 Bank Amount (USD) Start Date End Date Basis points Resettlement Freq StanC 5,000,000 5/6/2009 5/31/2010173.60 1 Month StanC 10,000,000 12/29/2009 6/27/2010 60.00 1 Month StanC 20,000,000 2/16/2009 8/15/2010 50.00 1 Month StanC 10,000,000 3/17/2009 9/13/2010 51.00 1 Month HSBC 10,000,000 2/16/2009 8/17/2010 68.00 1 Month HSBC 4,500,000 3/21/2009 6/19/2010 60.00 1 Month Bank Am 15,000,000 3/3/2009 6/2/2010 59.00 1 Month SBI 25,000,000 4/28/2009 5/28/2010 51.00 1 Month CITI 20,000,000 4/3/2009 9/3/2010 -10.30 1 Month CITI 10,000,000 3/17/2009 9/13/2010 75.00 1 Month
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CITI 20,000,000 2/16/2009 8/15/2010 82.00 1 Month CITI 5,000,000 3/17/2009 9/13/2010 40.00 1 Month
Exhibit 6:
Terms and details of the PCFC loan taken by the Company Interest rate is reset every 1 month and it is linked to the 6 M USD Libor rate plus the basis point as indicated against each of the PCFC. The valuation of a PCFC loan is done as follows: Where all the symbols have the same meaning as described above the market value obtained is in USD and to obtain the corresponding INR value, the USD value is to be multiplied with the spot USD/INR exchange rate. Because of the dependence of INR value on interest rate and exchange rate, the value of a PCFC is subjected to both interest rate and forex risk.
Advances
The Company has given advances to its subsidiaries for their operation. The details of the advances are shown in Exhibit 7 below3. 3 Advances have been given to subsidiaries other than Falcon and Betapharma as well. However, they are not considered here for 2 reasons: 1. They are insignificant compared to advances to Falcon and Betapharma 2. The notional currency for them is INR; hence there is no forex risk for those subsidiaries
P*(1+CP/12) (ZD)*CP (1+DR/12) D/Z B Market Value =16

Subsidiary Amount Start Date Basis points Resettlement Freq Falcon USD 39,000,000 1/1/2010 150.00 3 Months. Betapharma EUR 26,000,000 2/16/2010 175.00 3 Months.
Exhibit 7:
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Details of the advances to Falcon and Betapharma the market value of the advances is calculated in the same way as that for the loan above. It is copied below for convenience. The symbols have same meaning described earlier. The value obtained will be in respective currencies and hence need to be multiplied with appropriate spot exchange rate to determine the value in INR. Because of the dependence on both interest rate and exchange rate, advances are subjected to both interest rate and Forex risk.
Calculation
The calculations shown below are the snapshot of VaR estimate for the portfolio of Dr.Reddys as on a particular day. Hence the estimates shown below should not be taken to be conclusive. It would change with the changes in the portfolio. Moreover, these calculations are done for determining the method that gives a better estimate of VaR. Variance-Covariance method is not taken for the calculation purpose because of the complexity involved in assigning weightage to each of the market variable manually. Parameters Method Overall Risk Interest Rate Forex Risk Historical Simulation Rs. 20.7 Crores Rs. 0.11 Crores Rs. 20.6 Crores Constant Maturity Rs. 24.2 Crores Rs. 0.14 Crores Rs. 24.0 Crores TH 1 day and CL 95% Monte Carlo Simulation Rs. 16.0 Crores NA NA Historical Simulation Rs. 38.6 Crores Rs. 0.23 Crores Rs. 38.4 Crores Constant Maturity Rs. 34.1 Crores Rs. 0.197 Crores Rs. 33.9 Crores TH 1 day And CL 99% Monte Carlo Simulation Rs. 24.7 Crores NA NA
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Historical Simulation Rs. 98.5 Crores Rs. 0.68 Crores Rs. 97.8 Crores TH 1 Month And CL 95% Constant Maturity Rs. 91.5 Crores Rs. 0.73 Crores Rs. 90.7 Crores Historical Simulation Rs. 111.3 Crores Rs. 1.16 Crores Rs. 110.1 Crores TH 1 Month and CL 99% Constant Maturity Rs. 127.2 Crores Rs. 1.03 Crores Rs. 126.2 Crores P*(1+CP/4) (ZD)*CP (1+DR/4) D/Z B Market Value =17 Back-testing of various models has not been considered in the absence of more sophisticated techniques. Hence, another criterion for comparison can be the conservative nature of the estimate. We can see that Historical Simulation Method gives the most conservative estimate for a time horizon of 1 day and 99% confidence level. Hence it can be used for the VaR estimation in case a conservative estimate is desired. However, Variance-Covariance method can also be looked at before making any decision. The calculations are shown in the attached files: E:\Summers\FinalPresentation\VaREstimation\HistoricalReturnDaily.xls E:\Summers\FinalPresentation\VaREstimation\HistoricalReturnMonthly.xls
HOW TO USE VAR?

Because of the variability in the market condition, businesses run the risk of losing because of possible adverse market movement. However, with the advent of derivative products and various other hedging mechanisms, it is possible for treasury department to hedge the cash flows such that irrespective of the market movement, the company has a risk-free cash flow. But it has a downside to it. While the Company stands to lose from adverse market movement, at the same time it can gain substantially if the market moves favorably for the Companys portfolio. So, if treasury hedges the entire portfolio, the Company will miss out the opportunity to
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gain from any such movement. One alternative to this is that instead of hedging the entire portfolio, treasury hedges a portion of it so that in case of adverse market movement, the Company would incur a loss; however the loss is within the comfort level of management, or in other words, the Company can absorb the loss without any hiccup. And needless to say, the Company stands to gain from favorable market movement. And that is where VaR estimate comes into picture. VaR estimate gives an idea of what is the maximum loss that the Company can incur in a given time horizon with a specified confidence level. By monitoring VaR on a day-to-day basis, treasury would assess whether the Company can sustain the level of loss indicated by VaR or not. As long as the possible loss is within the target level, treasury would be free to operate in a way they deem fit for the Company. However, as soon as the estimate exceeds the target level, the onus will be on treasury to hedge the portfolio so as to bring the VaR value within the range.
Hence the following steps are involved in using VaR: 1. Determine the target level for the maximum loss that the Company can absorb over a given time horizon after discussion with the management. This can be either an absolute value or as a percentage of the portfolio value. 2. Determine the time horizon and confidence level for VaR estimation. 3. Track the VaR estimate over the determined time horizon and confidence level daily.19 4. If the VaR estimate is within the target level, treasury is autonomous to operate in a Way they deem fit for the Company. 5. However, if the estimate exceeds the level, treasury is mandated to hedge the Portfolio risk so as to maintain the VaR estimate within the target level. 20
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LIMITATIONS OF VAR
Although VaR is the most used method of risk assessment, it is not panacea of risk measurement methodologies. According to theory of coherent risk measures, any measure of risk should possess the following properties: 1. Monotonous 2. Sub-additive 3. Positively homogeneous 4. Translation invariant Detail of these properties is out of scope of this project. The reason to discuss these Properties is to bring forth the point that VaR estimate is not sub-additive, meaning it is Possible to construct two portfolios A and B such that VaR (A + B) > VaR (A) + VaR (B). This is counter intuitive as portfolio diversification is expected to decrease The risk. Another limitation of VaR is that although it successfully estimates the amount of maximum loss that one can expect to incur with a given confidence level, it fails to say anything about the expected value of loss provided the loss is greater than the VaR estimate. For Ex: If 99% daily VaR of a portfolio is say, 10 million, then on an average, 99 days out of 100, the portfolio loss over a time horizon of 1 day would be less than 10 million. However, on 1 day, the loss can be greater than 10 million. VaR estimate does not say anything about the loss on such a day. This estimate is important because although it has a probability of occurring only 1% or 5% of the times (depending on the confidence level), if this loss is huge, it can wipe off a significant proportion of the portfolio value. VaR does not provide any warning against such a disastrous situation. One measure of this loss figure is Conditional value-at-risk which gives the expected loss conditional on the information that the loss is more than estimated by the VaR 21
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CHAPTER V
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CONCLUSIONS:
Risk is sometimes referred to as the possibility of loss or injury. This is termed as peril. A hazard is a condition that serves to increase the occurrence of perils. T here is different types of hazards such as physical hazards, moral hazards and moral hazards. There are two types of losses: direct losses and indirect losses. Direct losses refer to the loss of an object that is exposed to risk, such as property. Indirect losses refer to the losses arising from direct losses. There are four levels of uncertainty based on our ability to forecast the outcome and the probability of that outcome. They are certainty, objective uncertainty, subjective uncertainty and complete uncertainty. In the first case the outcomes are certain, in the second case the outcomes can be identified with known probabilities. Risks are of different types. Pure risk refers to the risks that always result in losses. Speculative risk refers to a risk to a risk from which a possibility of a gain of loss exists.
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Dynamic risk arises out of changes in the environment which may be political, economic or social, whereas static risk is unaffected by changes in the environment.
Depending upon human attitude towards risk whether he is risk averse or a risk lover the strategy to manage risk varies. Risk can be avoided or prevented by risk avoidance, loss control, loss prevention, loss reduction and risk transfer. Insurance is one methods of transferring risk to a third party by paying a premium for the same.
As risk emanates from different activity, the focus of risk management should be on making other managers realize the implication of their actions on the organizations risk level and learn to manage it
Risk management widely perceived as an attempt to manage firms risk levels using various available sources out of which insurance is the most commonly used one
It s imperative that risk manager must have a holistic approach. Ignorance of risk management is still the main reason given by many corporate entities for not practicing it.
Risk identification is the basic task of risk management of any organization. The risks to which a company is exposed to should be identified by exploring the organization risks from various environment in which the organization functioning
Risk identification includes the study of hazards, which are the conditions that influence the causes of occurrence of losses. An organization should find out the hazards carefully in order to prevent the losses
Risk evaluation is the final phase of risk identification job. In order to evaluate it properly, past facts and figures about losses are to be collected properly; these historical data will help to find out the chances of losses and it level of severity
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CHAPTERVI
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SUGGESTIONS
WHAT TO DO ABOUT THE RISK? The recourse available to banks could be If the risk is at the prospective stage, try to avoid it. If the risk is likely to occur, and it is unavoidable, accept the risk and retain it in an economically justifiable basis. Try to execute some effective actions as to reduce or eliminate the loss likely to be incurred due to happening of the particular risky incident. Sound risks measurement procedures and information systems, if put in place in the right perspective, will help in taking timely decisions for avoidance of risk. Monitor various categories of risks on continuous basis and report to appropriate authority that risk can be overcome in future.
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Company should adapt new policies to cover the risk advantages in the old policy. So it is better for the company to have mutual fund in finance sector. Liquidate the risk by transfer without recourses to other party. Put in place the comprehensive internal control audit systems with a view to controlling risks. Risk management is not a destination, but a journey. It is not a on a time exercise but a lifetime exercise, which need to be undertaken repeatedly. Over the time, with identification of new risks, there is need to identify new risk management. Dr. Reddys has grown quite significantly in the recent past, both organically and inorganically. The recent acquisition of Betapharma was the largest for any Indian company. However, with these growths, the risk profile of the Company has also grown tremendously. And this is more so in recent times with increased variability of interest rate and exchange rates. In the wake of these developments, it is imperative to have a system in place to manage the risk effectively, so that the management can focus on what they do best; manufacture and sell pharmaceutical products. VaR is one such measure. Although it is not the only method for risk assessment, it is most widely used and one of the simplest to implement. Based on the study made in the project and analysis of the Companys portfolio, following are the recommendations: 1. Procure software for the estimation of VaR on a daily basis. 2. 99% confidence level to be used. 3. Historical Simulation method is more suitable for 99% daily VaR as it gives more Conservative estimate. 4. VaR should be implemented along with Conditional VaR, so as to monitor the
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Expected loss provided the loss exceeds VaR estimate. 5. Both interest rate risk and Forex risk should be estimated and if possible, Independently. 6. VaR can be used to assess the performance of treasury. Viability of this should be studied in more details. In case the VaR estimate exceeds the target level, treasury should hedge the portfolio appropriately. Various hedging techniques available in India are:Hedging techniques available in India Rupee-Foreign Currency Forward Contracts Currency Swaps Cross Currency Forward Contracts Interest Rate Swaps Forward-to-Forward Contracts Currency Options FRA Interest Rate Options 22
CHAPTERVII
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BIBLIOGRAPHY:
BOOKS: 1. Risk Management review by Sri Prasanna Chandhra. 2. Financial Management review by M.Y.Khan. 3. Credit Risk review by S.K. Bagchi. 4. Company profile of Reddys Lab. Websites: www.reddyslab.com www.riskglossary.com www.wikipedia.com
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Risk Management APR

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Risk Management APR

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Pure Vs. Speculative Risk

Classification of Pure Risks

Loss of Income Risk

Dynamic vs. Static Risk

Fundamental vs. Particular Risks

Attitude towards Risk

Human Response to Risk

OBJECTIVES OF THE STUDY

statements of the corporation, Annual reports of the company.

Limitations of the study

PROFILE OF THE COMPANY

1995 Sets up of a Joint Venture in Russia. 1997

1998 Licenses anti-diabetic molecule, DRF 2725 (Ragaglitazar), to Novo Nordisk

2004 Acquires Trigenesis gives access to drug delivery technology platforms

Dr. Reddy's has seven Board-level Committees, namely

AWARDS AND ACCOLADE

Risk Management Techniques:

Steps in the risk management process Establish the context

The Effect of Risk

Potential risk treatments

RISK MANAGEMENT ESSENTIALS

Nature of Risk Management

Hardware Software failure Organization failure Human failure

Development of Risk Management

Corporate Risk Management

TYPES OF RISK BUSINESS RISKS

ii. Credit risk:

Volume of off-balance-sheet exposures having a bearing on the credit portfolio.

iii. Market risk:

iv. Earnings risk:

vi. Business strategy and environment risk:

vii. Operational risk:

viii. Group risk factors:

I. internal control risk:

ii. Organizational risk:

iii. Management (including corporate governance) risk:

iv. Risk from the compliance angle:

RISK MANAGEMENT TECHNIQUES

RISK MANAGEMENT PROCESS

Exhibit 3: The distribution function of the return on market value usually a

VaR Variance-Covariance Method

Constant Maturity Model

Monte Carlo Simulation

P*(1+CP/12) (ZD)*CP (1+DR/12) D/Z B Market Value =16

HOW TO USE VAR?

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P(1+CP/12) (ZD)CP (1+DR/12) D/Z B Market Value =16