risk and uncertainty new

7/29/2019 Risk and Uncertainty New

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RISK AND UNCERTAINTY


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GroupMembers

Atul P Mumbarkar

44

Nimesh S Sawant 65

Praful Bhalerao 4

Rahul H Kadam 23

Umesh More - 41


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Introduction Inrealworld,mostfutureeventsarenotknown

touswiththeirdegreeofcertainty.

Managersaresupposedtotakedecisionrelying

onsomeestimateswhichagaininvolvessomeuncertainty.

So,Riskanduncertaintywillalwaysbeapartofouranalysis.


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WhatisRisk?

Riskreferstothesetofuniqueoutcomesforagiveneventwhichcanbeassigned

probabilities


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Inotherwords,wecanalsodefineriskas,aprobabilityorthreatof

adamage,injury,liability,loss,orothernegativeoccurrencethatiscausedbyexternalor

internalvulnerabilitiesandthatmaybeneutralizedthroughpreemptiveaction.

WhatisRisk?


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WhatisUncertainty

Uncertaintyreferstotheoutcomesofgiveneventwhicharetoounsuretobeassigned

probabilities


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WhatisUncertaintyIn other words, we can define Uncertainty as a

decision making situation where the current stateofknowledgeissuchthat

theorderornatureofthingsisunknown,

theconsequences,extent,ormagnitudeofcircumstances,conditionsoreventsisunpredictableand

credibleprobabilitiestopossibleoutcomescannot

beassigned.


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RiskV/sUncertainty

Riskiswhenfutureeventscanbedefinedandprobabilitiescanbeassignedanduncertaintyiswhen future events cannot be defined andprobabilities of it occurrence cannot be

assigned.


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Risk and Uncertainty are concepts that talkabout expectations in future, butwhereas youcan minimize risk by taking some preventivemeasures to face an uncertain future, but youcannotremoveuncertaintyfromlifealtogether.

RiskV/sUncertainty


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RiskiswhenweknowtheoutcomeofanygivenactivityoreventbutUncertaintyiswhenwedonotknowanythingabouttheoutcomeof

anygivenactivityorevent.

RiskV/sUncertainty


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Riskiscalculableandmeasurablewhileuncertaintyisnot.

RiskV/sUncertainty


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Risk,ifcalculated,canbeinsured.

Thus,insurancecompaniescanpredictwithahighdegree of accuracy the probabilities of deaths,accidents, and fire losses. These probabilities

enable them to make decisions about premiumlevelsanrates.

RiskV/sUncertainty


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Adecisionmaking situation in which the possibleoutcomes can vary and the probability of theoccurrenceofeachoutcomeisknownissaidtobeariskysituation

While a decision making situation, in which thepossible outcome aremany and the probability ofthese outcomes are not known is said to anuncertainsituation.

RiskV/sUncertainty


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RiskAttributes Risk Aversion:Individuals seek to avoid or minimize risk. Adescription of an investor who, when facedwithtwo investments with a similar expected return

(but different risks), will prefer the one with thelowerrisk.


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Manhole


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RiskAttributes Risk Neutrality:Individuals focus on expected returns anddisregard the dispersion of returns (risk). A risk-neutral investor is more concerned about the

expectedreturnonhisorherinvestment,notonthe risk he or she may be taking on.


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Manhole


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RiskAttributes Risk Seeking:Individualspreferrisk.

Riskseekersmightpursueinvestmentswhicharerisky.


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Manhole


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RiskAttributes Choice between more risky and less risky

investmentswithidenticalreturns:

Riskaverterchoosestheonewithlessrisk

Riskseekerchoosestheonewithhighrisk

Riskneutralisindifferentbetweenthechoices


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TypesofRisk

Types ofRisks

MARKETRISK

CREDIT RISK

LIQUIDITYRISK

OPERATIONALRISKLEGAL AND

REGULATORYRISK

BUSINESSRISK

STRATEGICRISK

REPUTATIONRISK


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MarketRisk Market risk is the risk that changes in financialmarketpricesandrateswillreducethemonetaryvalue (e.g. Rs., US $, UK ) of a security or aportfolio.

Therearefourmajortypesofmarketrisk

1. InterestRateRisk

2. EquityPriceRisk

3. ForeignExchangeRisk

4. CommodityPriceRisk


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TypesofMarketRisk Interest Rate Risk: Thesimplestformofinterest

rate risk is the risk that the value of a fixedincomesecuritywillfallasaresultofanincreaseinmarketinterestrates.

Equity Price Risk: The risk associated with

volatilityinstockprices.Thegeneralmarketriskofequityreferstosensitivityofaninstrumentor

portfoliovaluetoachangeinthelevelofboardstockmarketindices.


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Foreign Exchange Risk:Foreign exchange risk arises from open or

imperfectly hedged positions in a particular

currency. These positions may arise as anatural consequence of business operation,ratherthanfromanyconsciousdesiretotakeatradingpositioninacurrency.

TypesofMarketRisk


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Commodity Price Risk:Thepriceriskofcommoditiesdiffersconsiderablyfrom interest-rate and foreign exchange risk,

sincemostcommoditiesaretradedinmarketinwhichtheconcentrationofsupply inthehandofafewsupplierscanmagnifypricevolatility

TypesofMarketRisk


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CreditRisk

Creditriskistheriskthatachangeinthecreditqualityofcounterpartywillaffectthevalueofsecurityoraportfolio.


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LiquidityRisk

Liquidityriskcomprisesbothfundingliquidityriskand asset liquidity risk, although these twodimensionofliquidityriskarecloselyrelated.


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LiquidityRisk

Funding liquidity risk relates to a firmsabilitytoraisethenecessarycashtorolesoveritsdebt;tomeet the cash , margin and collateralrequirementsofcounterparties:and(inthecase

offund)tosatisfycapitalwithdrawals.


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LiquidityRisk

Assetliquidityrisk,oftensimplycalledliquidityrisk,is the risk that an institution will not be able toexecute a transaction at the prevailing market

pricebecausethereis,temporarily,noappetiteforthedealontheothersideofthemarket.


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OperationalRisk

Operational risk refers to potential lossesresultingfrominadequatesystem,managementfailure,faultycontrols,fraud,andhumanerror


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LegalandRegulatoryRisk

Legal risk is a type of risks that means that acounterparty is not legally able to enter into acontract. Another legal risk relates to regulatory

risk, i.e., that a transaction could conflict with aregulator's policy or, more generally, thatlegislation might change during the life of afinancialcontract.


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BusinessRisk

Business risk refers to the classic risk of theworldofbusiness,suchasuncertaintyaboutthe

demand for products, the price that can bechargedforthoseproducts,orcostofproducinganddeliveringproducts


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StrategicRisk

Strategic risk refers to the risk of significantinvestments for which there is high uncertaintyaboutsuccessandprofitability.Iftheventureisnotsuccessful,thenthefirmwillusuallysufferamajor

write-off,anditsreputationamonginvestorswillbedamaged.


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ReputationRisk

Reputationriskistheriskofcausinganyharmtothereputationofanyindividualororganizationincase of any scam or scandals. For example,

there was a reputation risk to Price WaterCooper house accounting firm due to Satyamscam.


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General Methods of Dealing with Uncertainty Referral to authority for guidance:This is a very pragmatic to the reduction ofuncertainty.Insomecases,thereisliteralauthoritysuch as wage boards, industrial relations

commission ,bureau of industrial costs and prices.Whatever such authorities decide, managementacceptsthem


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Control of the environment:Thisapproachusuallytakesthefromofattemptsto gain a monopoly by means of patents,

exclusive dealership, contacting and influencingimportantofficialswhomatteretc.

General Methods of Dealing with Uncertainty


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Hedging:It is a very common method by which businessexecutivescan replace futureuncertaintywith thesecurityofapresentcontract.hedgingtakesmany

forms;itemergesmostcommonlyinthewritingofcontractsforgoodsandservices,andittradingof

futuresatcommodityexchanges.



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Diversification:Thisiscloselyrelatedtoflexibility.Thereisanoldadagedontputallyour-eggsinonebasket".in

view of this, to minimize risk and uncertainty,business often, go for diversification of theirproducts,sourceofrawmaterials,marketsetc.



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Modification of goals:In the face of complete uncertainty, an optimaldecisionmightbeimpossible.Knowingthis,many

timesabehavioral firm, youmay recall, attemptsmodificationofitsgoal-itstargetvariables.Thisisa practical approach to face the uncertainenvironment.



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Flexible investments:The investor often takes care of flexibility whiledeciding on long run investment. For example, a

general-purposemachine.but whenchangesandfrequent, it is less riskier to invest in a general-purposemachine.



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Purchasing Insurance:We all purchase insurance policies that involves paying apremiumtoprotectourselvesagainstdifferentkindsofrisks-accident,fire,death,etc.Insuranceiscommonlyavailablefor losses due to fires, accidents at workplace, theft andfraud.whetheraninsuranceisrequiredornotdependsonthe degree of risk averseness of the buyers, theirassessmentoftheseverityoftheconsequencesoftheeventoccurring,andthepremiumitself.



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