 RISK  Variety of meanings for risk in business and our day today life.  Risk is used to describe any situation where there is uncertainty about what outcome will occur

 RISK  In probability, statistics, Financial management and Investment management, risk is often used in a more specific sense to indicate possible variability in outcomes around some expected value  Risk may also refer to the expected losses associated with a situation

 Risk  Eg. High risk policy-holder Expected value of losses to be paid by the insurer is high  Eg. Japan is a high risk zone for earthquake Expected losses from earthquake in Japan is higher than other countries

 RISK  Used in specific sense to describe variability around the expected value  And also to describe the expected loss

one situation is riskier than Another if it has greater EXPECTED LOSS UNCERTAINITY (Variability Around expected loss )

 RISK IS COSTLY  Greater risks implies greater cost

 POTENTIAL LOSSES  DIRECT LOSS If fire destroys a house, direct loss would be the price of the house  INDIRECT LOSS Indirect losses arise as a consequence of direct loss If a house is destroyed, the owner would have additional expenses such as hotel and restaurant bills When a person’s car is damaged, the time spent in getting the car repaired is an indirect loss

 For businesses, Indirect losses are extremely important  The possibility of indirect losses is one main reason that businesses try to reduce risk  For eg, A fire accident in factory will result in huge losses due to loss of sales

 TYPES OF INDIRECT LOSSES  Loss of normal profit ( Net cash flow)  Extra operating expenses  Higher cost of funds and foregone investments  Bankruptcy costs ( Legal fees )

TYPES OF RISK FACING BUSINESSES  Price risk  Credit risk  Pure risk

 PRICE RISK  Refers to uncertainty over the magnitude of cash flows due to possible change in output and input prices  The three specific types of price risks are Commodity price risk Exchange rate risk Interest rate risk

 Commodity price risk Due to fluctuations in price of commodities such as minerals, oil, gas, metals. These may be the input or output for a company  Exchange rate risk In this globalised business context, the input and output prices are affected by fluctuations in foreign exchange rates  Interest rate risk Changes in interest rate affects a firm’s cost of borrowing funds

 CREDIT RISK The risk that a firm’s customers and the parties to which it has lent money will delay or fail to make the promised payment Firms face credit risks for account receivables Firms will have to pay more to borrow money as credit risk increases E.g. Top credit risk is mainly for large financial institutions such as Banks when encounter large amount of loss.

 PURE RISK Risk of reduction in value of business assets due to physical damage, theft and expropriation What is expropriation? Risk of legal liability for damages to customers, suppliers, shareholders and other parties Risk associated with paying benefits to injured workers Risk of death, illness and disability to employees

 TYPES OF RISK FOR INDIVIDUALS  Earnings  Medical expenses  Liability  Physical Assets  Financial Assets  Longevity

 Risks associated with Earnings  Due to death  Due to disability  Due to aging  Due to unemployment

 Risks associated with Medial expenses

 Risks associated with Liability  Related to automobiles  Liable for death caused by accident  In India, Government has made it mandatory for all individuals involved in driving of vehicles to take insurance for covering against this liability

 Risks associated with Physical Assets  Damages to Automobiles  Damages to Home  Damages to properties

 Risks associated with Financial Assets  Losses due to investments in shares  Losses due to investments in Bonds