UNIT-I

INTRODUCTION TO RISK MANAGEMENT

-M.vasudevarao
Risk: refers to the probability of actual return becoming less than the
expected return.

Risk includes the possibility of losing some or all of the original

investment.
Risk management: refers to the practice of identifying potential risks in

advance, analyzing them and taking precautionary steps to reduce the

risk.
Risk Management: is the identification, analysis, assessment, control,

and avoidance, minimization, or elimination of unacceptable risks.

Risk Management Process:
*****Sources of Risk/ components of Risk:

Sources
of Risk

I. Systematic risk II. Unsystematic risk

a. b. c. Purchasing
a. Business b. Financial
Market Interest power risk /
risk rate risk Inflation risk risk risk
*****Sources of Risk/ components of Risk:
The may be involved from two sources.
I.Systematic risk :
a)Market risk
b)Interest rate risk
c)Purchasing power risk / Inflation risk
II.Unsystematic risk :
a)Business risk
b)Financial risk
I . Systematic Risk : is the risk caused by the external factors . These are
uncontrollable by the company. It affects the entire market.
a)Market risk: The price of a stock may fluctuate widely within a short
span of time even though earnings remain unchanged.
b)Interest-rate risk: The risk of variations in future market values and
the size of income, caused by fluctuations in the general level of
interest rates is referred to as interest-rate risk.
c)Purchasing-power risk/inflation: Purchasing-power risk refers to the
uncertainty of the purchasing power of the money to be received. In
simple terms, purchasing-power risk is the impact of inflation or
deflation on an investment.
II.Unsystematic Risk: is the risk caused by the internal factors in the
company such as managerial inefficiency, technological changes in
production, labour problems etc., These are controllable factors.
a) Business risk: Business risk relates to the variability of the
sales,income, profits etc., which in turn depend on the market
conditions for the product mix, input supplies, strength of Competitors,
etc.
b)Financial Risk: This relates to the method of financing, adopted by
the company; high leverage leading to larger debt servicing problems
or short-term liquidity problems due to bad debts, delayed receivables
and fall in current assets or rise in current liabilities.
Risk Management Framework:
 Financial Institutions

Financial Institution is an organization that acts as a channel

between savers, bowers and providers of capital.

Financial institutions includes banking and non-banking

institutions.
ROLE OF FINANCIAL INSTITUTIONS:
1. Trade Development
2. Agricultural Development
3. Industrial Development
4. Capital Formation
5. Development of Foreign Trade
6. Transfer of Money
7. Development of Transport
8. Safe Custody
9. Increase Savings in the Country
10. Financial Innovation
11. Availability of Financial services to households & individuals
*****Identification of Financial Risks or
Types of financial risks:
Major market risks are usually the most obvious type of financial risks
that an organization faces. They are:
I. Foreign exchange risk
II. Interest rate risk
III. Commodity price risk
IV. Equity price risk
V. Credit risk
VI. Operational risk
VII. Liquidity risk
I. Foreign exchange risk:
Foreign exchange risk arises through transaction, translation, and
economic exposures.
It may also arise from commodity-based transactions where
commodity prices are determined and traded in another currency.
II. Interest rate risk :
Interest rate risk arises from changes in the level of interest rates.
III. Commodity price risk: is arises due to adverse changes in the prices
of commodity.
IV. Equity price risk:
Equity price risk affects companies’ ability to fund operations through
the sale of equity and equity-related securities.
V. Credit risk : is the probable risk of loss resulting from a borrower’s

failure to repay a loan or meet contractual obligations.

VI. Operational risk: Operational risk arises from human error and

fraud, processes and procedures, and technology and systems.

VII. Liquidity risk: is the risk that an organization has insufficient

liquidity to maintain its day-to-day operations(short-term).

Financial intermediary is an institution or entity that acts as a
middleman among diverse parties in order to facilitate financial
transactions. Such as commercial banks, investment banks,
stockbrokers, mutual funds, and stock exchanges etc.,
*****Financial services provided by the
intermediaries:
The following are some of the financial services provided by the financial intermediaries.
I. Banking services
II. Insurance services
III. Stock Broking services
IV. Wealth Management services
V. Investment Banking services
VI. Mutual fund services
VII. Mortgage services
VIII. Housing and vehicle financing services (loans)
IX. Leasing services
X. Factoring services
XI. Venture Capital
XII. Merchant Banking
XIII. Underwriting services