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EDS - MARCH 2014

Risk &
Investment

get a detailed overview of the various risks in
the management of a corporation
understand the role of environmental and
strategic factors that could impact the business
or organizational profile
work through hands on workshops to complete
scoring models for credit risk, sensitize cash
flow projections and use other tools of risk
management
discuss and consider what further information
and verification is required to strengthen the
analysis
Understanding Your business
Please state :

1. Your Name and Position in your organization
2. What are the key identified risks
3. What Enterprise Risk Management or other tools you
already use
4. Your expectations
PROGRAM TOPICS
THE INVESTMENT SIDE
Cash Flow projections
Sensitivity Analysis
Defining Risk & Risk Attitudes
Types of Risk impacting Corporations e.g.
Financing risk
Credit risk
Interest rate risk
Global risk
Modelling the environmental risk impacting our financial institution:
Where weve been recently The Global Recession
Using the Inverted Triangle Analysis to score market risk factors on
our loan portfolio and other financing products.

A broad approach to risk management in Financial Services (overview session)
COSO Framework
ATEM Rule
Basel II
Capital Adequacy
CAMELS
MEASURING RISK
Portfolio Risk for Investment Banking
5Cs Credit Risk Individuals
5Cs Credit Risk Business borrowers
ON GOING MEASURES OF RISK IN BUSINESS INVESTMENT
Sensitizing key business factors
Leverage Analysis
RECOGNIZING RED FLAGS
RISK
&
INVESTMENT
Investment is Risky
Investment requires sacrifice of current consumption for
potential future gain.

SACRIFICE is current
RETURNS are:
In the FUTURE
Therefore UNCERTAIN (Risky)


About RISK in Investment
The fact that people are full of greed, fear, or
folly is predictable. The sequence is not
predictable.
Warren Buffett
The major difference between a thing that
might go wrong and a thing that cannot possibly
go wrong is that when a thing that cannot
possibly go wrong goes wrong it usually turns
out to be impossible to get at or repair
Douglas Adams
Current scenarios
Changing course on the
economy would plunge the UK "back into the
abyss", David Cameron has said.
Mr Cameron said: "There are some people who
think we don't have to take all these tough decisions
to deal with our debts. They say that our focus on
deficit reduction is damaging growth, and what we
need to do is to spend more and borrow more.
"It's as if they think there's some magic money tree.
Well, let me tell you a plain truth: there isn't."
It is subject to
TIME VALUE OF MONEY
1. Currency Fluctuations
2. Investment Opportunities
3. Increasing uncertainty with longer time and
planning horizons
4. Liquidity Preference
5. Time cost of money = INTEREST RATES

Everything that can be counted does not necessarily count;
everything that counts cannot necessarily be counted.
Albert Einstein
FOREX RISK
Risk on either payment or potential income in a foreign
currency

HEDGING STRATEGIES:
LEADING
LAGGING
FORWARD CONTRACTS
MONEY MARKET OPERATIONS
MATCHING
NETTING
DERIVATIVES
TIME VALUE OF MONEY
measured using Discount
Rates
COMPUNDING = Value of a cash flow at a specific point of
time in the future

DISCOUNTING = Value today, of a cash flow arising in the
future

TEMPLATE FOR INVESTMENT


APPRAISAL
INVESTMENT APPRAISAL PROCESS
IDENTIFICATION OF INVESTMENT NEED OR
OPPORTUNITY
ENVIRONMENTAL ANALYSIS ( SWOT & PESTEL )
ASSESSMENT OF STRATEGIC FIT ( BCG MATRIX )
PREPARATION OF PROJECTED CASH FLOWS
ANALYSIS OF PROJECTED CASH FLOWS
FINANCING CONSIDERATIONS
RISK CONSIDERATIONS
DECISION MAKING
Key Questions to Answer
WHAT IS THE CAPITAL RECOVERY PERIOD
- PAYBACK PERIOD
WHAT IS THE CASH SURPLUS AFTER COVERING ALL COSTS
- NET PRESENT VALUE
WHAT IS THE RATE OF NPV PER $ INVESTED
- PROFITABILITY INDEX
WHAT IS THE DCF RATE OF RETURN ON THIS INVESTMENT
- INTERNAL RATE OF RETURN
Seven Principles of Behavioral Economics
that apply to RISK MANAGEMENT
1. Other peoples behavior matters
People do many things by observing others and copying; people are
encouraged to continue to do things when they feel other people
approve of their behavior.
2. Habits are important
People do many things without consciously thinking about them.
These habits are hard to change even though people might want to
change their behaviour, it is not easy for them.
Seven Principles of Behavioral Economics
that apply to RISK MANAGEMENT
3. People are motivated to do the right thing
There are cases where money is de-motivating as it undermines peoples
intrinsic motivation, for example, you would quickly stop inviting friends to
dinner if they insisted on paying you.
4. Peoples self-expectations influence how they behave
They want their actions to be in line with their values and their
commitments.

Seven Principles of Behavioral Economics
that apply to RISK MANAGEMENT
5. People are more afraid of incurring losses than making profits
They hang on to what they consider theirs.
6. People are bad at computation
when making decisions: they put undue weight on recent events and too
little on far-off ones; they cannot calculate probabilities well and worry too
much about unlikely events; and they are strongly influenced by how the
problem/information is presented to them.
Seven Principles of Behavioral Economics
that apply to CREDIT RISK MANAGEMENT
7. People need to feel involved and effective to make a change
Just giving people the incentives and information is not necessarily enough.
Summary
Economics is not wrong science and is also a study of human
behavior but certain assumptions are generalized and not seem
empirical or practical which may bring ambiguity at times. Behavioral
Economics teaches us:

To avoid making serious mistakes down the road.
Clarify what is rational and irrational decision making.
Lead to a better understanding of opportunity costs, time
discounting, and other economic concepts.
Provide a richer, more realistic understanding of decision making in
practice.

WORKSHOP
How would you define risk for the business of a selected
business ?

Is Risk all bad news ?

Can Risk be Managed ?
RISK QUADRANT FOR
CONSTRUCTION SECTOR
8
/
1
/
2
0
1
4

D
r

H
a
r
w
i
n
d
a
r

S
i
n
g
h


RISK
MODELS

TOOLBOX OF CUSTOMER
CREDIT RISK ASSESSMENT
CREDIT PROFILING
FINANCIAL ANALYSIS
LEVERAGE ANLYSIS
SENSITIVITY ANALYSIS
COLLATERAL ANALYSIS
FORWARD ANALYSIS

CREDIT PROFILING
Use of Harvey Gill 5 Cs Risk Rating
Business borrower
Business controlled by individual / individual borrower
Identify category of borrower
(A to D)
Other scoring models
BEVERAGE COMPANIES
FINANCIAL ANALYSIS to
evaluate
REPAYMENT CAPACITY RISK
Cash Ratio
Working Capital Ratio
Interest Cover
Income Generation
Operating Profitability
Net Profitability
RISK ANALYSIS IS BASED ON :
Significant Changes in trends
Value of key ratios within acceptable limits
LEVERAGE ANALYSIS
SENSITIVITY ANALYSIS
For discussion on Day 2
Data Required:
Analysis of business costs as fixed and variable
Business VOLUME
Contribution Rate
Tax Implications
ANALYSIS :
Sensitivity of bottom line to business volume
Breakeven or tolerance level
COLLATERAL ANALYSIS
Valuation bases for:
Landed Property
Financial Assets
Cash Assets
must be clearly established so that margin of financing can be
determined without hurting the risk profile of the overall loan
portfolio
FORWARD ANALYSIS
Inverted T Analysis
Cash Flow Projections which must be :
Sensitized
Analyzed as per:
NPV
IRR
PAYBACK PERIOD
INVESTMENT
ISSUES
INVESTMENT TYPES
APPLICATION & RELATED TENURE
FIXED ASSETS
WORKING CAPITAL
MONETARY ASSETS
AMOUNT / SIZE / MIX
EXPECTED RETURNS
ACCEPTABLE RISK
OTHER FACTORS

INVESTMENT ANALYSIS
MARKET INVESTMENT
FUNDAMENTAL ANALYSIS
TECHNICAL ANALYSIS
HOLDING PERIOD RETURN (HPR / TWRR)
CORPORATE INVESTMENT
RETURN ON INVESTMENT (ROI)
NET PRESENT VALUE (NPV)
INTERNAL RATE OF RETURN (IRR)
PAYBACK PERIOD
A BROAD
APPROACH TO
RISK
ASSESSMENT
Process
Level
Activity
Level
Entity Level
Risk
Monitoring
Identification
Measurement
Prioritization
Risk
Assessment
Source: Business Risk Assessment. 1998 The Institute of Internal Auditors

RISK STRATEGIES

ENTERPRISE RISK MANAGEMENT
Risk is defined as Uncertainty that can be estimated, tracked
and managed to some extent. (Dr. Harvey Gill)
There are FOUR approaches to uncertainty :
A - AVOID IT
T - TRANSFER IT
E - ELIMINATE IT
M - MANAGE IT : This is the scope of
CRM
PROJECT RISK PROCESS
THE COSO FRAMEWORK
Establish ERM
Determine a risk philosophy

Survey risk culture

Consider organizational integrity
and ethical values

Decide roles and responsibilities


WORKSHOP SESSION
Developing Investment Strategies Based on Risk Factors Eg.

1 POLITICAL
2 ECONOMIC
3 SOCIAL
4 TECHNOLOGY factors

ESTABLISH THE SPECIFIC EVENTS & DRIVERS
STATE PROBABILITY OF OCCURRENCE ON A SCALE OF 1 -10
WHERE 10 IS CERTAIN TO HAPPEN
PROVIDE SCORE FOR IMPACT FROM -10 TO +10
KEY IN THE DATA IN THE HARVEY GILL TEMPLATE
TIME TARGET : 30 MIN.
Financial Models for monitoring
and managing risk

CAPTURING TRENDS
REVENUE
OPERATING PROFIT
NET INCOME
NEW ASSET INVESTMENT
TOTAL BORROWING
CASH & CASH EQUIVALENTS
ANALYSIS OF THE STD
DEVIATION
UPTREND ANALYSIS
DOWN TREND ANALYSIS
FLUCTUATING MARKET CONDITIONS

IMPORTANT !!!
DEVELOP ACTION PLANS FROM ANALYSIS
MOODYS DEBT RATING SYSTEM
FOR OVERALL RISK ASSESSMENT
Ratings work best for ONE year
at a time !
The chart on the previous slide shows the Moody's Debt
Rating system along with the data that Moody's has
calculated for the default rate of bonds that defaulted
within one year of having a given rating for all companies
between 1970-2001.
You can see that Aaa means that no company has
defaulted within one year of having an Aaa rating. Zero
occurrences!
You can also see that only 1.21% of companies with a Ba
(Below Investment Grade or Junk Rating) have defaulted
within a year of having that rating.
LATEST ON DEFAULT RATES
* The ratings from Aa to Ca by Moody's may be modified by the addition of a 1, 2 or 3
to show relative standing within the category.
**The ratings from AA to CC by Standard & Poor's, Fitch IBCA and Duff & Phelps
may be modified by the addition of a plus or minus sign to show
relative standing within the category.
Rating Debt S&P Moodys & Z Score
US Equivalent Rating Average Z Score Sample Size
AAA 8.15 8
AA+ 7.6 -
AA 7.3 18
AA- 7 15
A+ 6.85 24
A 6.65 42
A- 6.4 38
BBB+ 6.25 38
BBB 5.85 59
BBB- 5.65 52
BB+ 5.25 34
BB 4.95 25
BB- 4.75 65
B+ 4.5 78
B 4.15 115
B- 3.75 95
CCC+ 3.2 23
CCC 2.5 10
CCC- 1.75 6
D 0 14
LEVERAGE ANALYSIS

DOL = EBIT + FOH / EBIT

DFL = EBIT / (EBIT FFC)

DTL = DOL * DFL
T H A N K Y O U ! ! !
WE HOPE THIS PROGRAM HAS
ADDED VALUE TO YOU LIFE !
harwindar@gmail.com