Insurance and Risk Management

Introductions

Overview of Risk management

 Overview of Risk Management

• Risk in finance refers to the uncertainty

associated with returns from an investment.
• In other words, is the chance of not meeting
one’s investment goals because of uncertainty
on returns over time.
 Types of risk
• Market/Price risk: refers to the change in an asset’s
price due to changes in market conditions; either
demand/supply conditions and/or sentiments. All
market traded asset instruments have exposure to
this risk.
• Inflation risk: refers to the loss of purchasing
power resulting from inflationary conditions. In a
highly inflationary environments, future
investment returns would be worth much less,
given the loss in the purchasing power.
 Cont..
• Interest rate risk: refers to the changes in asset values
due to changes in nominal interest rates. Here the risk
is that a change in interest rates can change the cost
of funds of financing.
• Default/Credit risk: refers to the changes in financial
integrity of the counterparty or the issuer of the asset.
Default risk is relevant because of possible
anticipatory losses. As a result, a financial instrument
can go down very substantially in price (close to
worthless) even though the issuer has not technically
declared bankruptcy.
 Cont..
• Liquidity risk: refers to risk that arises from illiquid
markets while one can not dispose off an asset
quickly. The only way to quickly sell the assets would
be by taking a big discount on the price.
• Currency/Exchange rate risk: refers to changes in
investment income as a result of changes in exchange
rates. Such risk arises every time someone engages in
a foreign currency denominated transactions/assets.
Even if the income is unchanged in foreign currency
terms, the amount could vary in domestic currency
terms if exchange rates change.
 Cont..

• Political risk: refers to the risk faced by international

investors. Most political risk is of a regulatory
nature. It refers to risks such as
expropriation/nationalization, imposition of
exchange controls that disallow foreigners to
withdraw their funds, the imposition of
unfavourable tax or ownership requirements etc.
political risk therefore refers to the diminution in the
value of foreign held assets as a result of
unfavourable regulatory change overseas.
 Risk Management

• Risk management refers to the process/technique

of reducing the risks faced in an investment.
• In other words, risk management is defined as
the logical development and implementation of a
plan to deal with potential losses.
• Risk management benefits all types of
organizations facing potential losses, including
among others, businesses, nonprofit
organizations, individuals and families.
• What makes risk management challenging is
risk-return trade-off, which means, that risk
and return are generally positively correlated.
The following graph shows the relationship
between risk-return trade-off.

Return (%)

Risk (%)
 Cont..

• Hence, risk management is recognized as

being concerned with both positive and
negative aspects of risk.
Avoid negative
consequences
Risk
management Achieve positive
consequences
 Cont..

• Risk management practices to avoid negative

consequences means to avoid financial distress and
to have sufficient capital.
• On the other hand, risk management practices are to
achieve positive consequences where risk is treated
as opportunity, not only to avoid financial distress
but also to meet the firm’s business objectives such
as increasing the value of shareholders by
improving their financial performances.
 Cont..

• Among the shareholder’s value objectives that are

expected to be meet by improving risk
management sophistications include among others,
protection against unforeseen losses, earnings
stability and maximize earnings potential.
• Therefore, risk management strategy which reflects
a balanced approach for business performance and
negative management can lead the organization of
sustainable value and greater business confidence.
 Cont..

• Thus, the survival and success of any

organization depends on the efficiency in
which they can manage its risks. Hence, risk
management is one of the critical factors in
providing better returns to the shareholders.
Thank You All