PALAWAN STATE UNIVERSITY

College of Business and Accountancy

Department of Accountancy
Puerto Princesa City

MODULE 1:
ENTERPRISE RISK
PrE 4: ENTERPRISE RISK MANAGEMENT
2ND Semester | SY: 2020-2021

BSA 3

LARA CAMILLE C. CELESTIAL, CMA, CTT

College of Business and Accountancy
Palawan State University
 TABLE OF CONTENTS

Title Page of Module 1

Table of Contents 2

Overview 3
Learning Outcomes 3
Summary of Topics 3

Content
Topic 1: Enterprise Risk 4
Topic 2: Types of Enterprise Risk 6

References 10

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 MODULE 1 |
ENTERPRISE RISK
Overview
Identifying and managing risks is an integral part of business planning as it helps
organizations to be informed and considered risks and assists with a strategic and
consistent approach to managing risk across the organization. Risk is
viewed as a condition that may prevent one from achieving an
objective. Organizations need to identify, assess, and manage risks to
achieve their goals, including protecting the organization's assets and
avoiding unexpected losses.

Module 1 will introduce risks and their types to you. Although risks
often are challenging to determine and quantify, management should
make the best effort to identify risks and their probabilities of
occurrence.

Intended Learning Outcomes:

 Define risk and expected loss
 Identify the different types of risks in the business context

Topics:
1: Risk
2: Types of Risk

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Topic #1: Enterprise Risk

Enterprise risk is a condition that may prevent

an organization from achieving its objective.
Some business risk is easy to locate. We put
sprinkler systems in buildings and buy
insurance policies to protect against fires. Retail
stores put magnetic detectors at entrance doors
to detect shoplifters and prevent theft. But
some enterprise risks, which are risks that
would cause losses or put the ability of the
business to function appropriately in jeopardy,
aren't always as easy to identify. Although risks
often are challenging to determine and quantify, management should make the best effort to
identify risks and their probabilities of occurrence.

Several organizations provide guidance to assist with the design and implementation of a
practical enterprise-wide risk management approach. The latter part of this course focuses on
the most widely used and accepted enterprise risk management framework, the COSO
Enterprise Risk Management Integrated Framework, a comprehensive approach to assessing
an organization's risk.

ENTERPRISE RISK AND EXPECTED LOSS

In a business context, risk the level of exposure to a chance of loss. For example, if a
company determines that a particular risk could result in a loss of up to $50,000, the company
would be willing to spend at the most $50,000 to mitigate the risk. The amount of loss
calculated by the company represents the maximum possible loss (extreme or catastrophic
loss). This loss often is referred to as the value at risk (VaR).

VALUE AT RISK
The historical performance over long periods provides an estimate of average rates of return
and high and low returns. But as the name implies, history offers a retrospective indication of
risk. When reviewing a portfolio, historical volatility illustrates how risky the portfolio was over a
period. It provides no representation of the current market risk of the portfolio. VaR gives
organizations the ability to assess current risk to the extent that losses from those risks are
distributed normally.

VaR is the maximum loss within a given time and at a given specified probability level (level of
confidence). Unlike retrospective risk metrics that measure historical volatility, VaR is
prospective. It quantifies market risk while it is being taken. VaR includes cash flow at risk,
earnings at risk, and distribution of losses arising from cash flow or earnings risks. Risk
models typically deal with identifiable risks and do not account for globally catastrophic events
such as nuclear war.

Many quantitative analyses can be used to show the impact of risk on an organization's
financial health. Cash-flow at risk, for example, can be modeled to demonstrate the likelihood
of various levels of cash flows. It can also be presented as the maximum cash flow loss within
a given time period. The same types of analyses can be used to calculate earnings at risk,
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which provides organizations with an idea of how earnings can change based on risks taken.
Earnings distributions and earnings per share (EPS) distributions are additional analyses that
show how financial health may respond to changes in the business environment. Using
quantitative tools helps companies understand how risks, which may seem abstract, influence
company performance in concrete ways.

Application VaR can be applied to any portfolio that can reasonably be marked
to market performance on a regular basis. VaR is not applicable to
illiquid assets such as real estate.
Time Frame/Horizon VaR evaluates a portfolio's performance over a specific period of
time, such as a trading day, week, or month.
Base Currency VaR measures risk in a currency. Any currency can be used.
VaR Measurement A resulting VaR measure summarizes a portfolio's market risk with a
single number.

VALUE AT RISK (VaR) METHODS:

The historical method estimates risk based on actual historical

returns for a time period by putting them in order from worst to best.
The historical method assumes that history will repeat itself from a
Historical Method risk perspective. A histogram plot correlates the frequency of returns
with losses. The results indicate the confidence level related to the
occurrence of a worst-case daily loss. (For example, if we invest
$1,000, we are 95% confident that our worst daily loss will not
exceed $40 ($1,000 × 4%).)
The variance-covariance method assumes that stock returns are
Variance- normally distributed. Expected (or average) return and a standard
Covariance Method deviation are estimated, and a normal distribution curve is plotted.
By reviewing the normal curve, one can see exactly where the worst
percentages lie on the curve.
A Monte Carlo simulation refers to any method that randomly
Monte Carlo generates trials. This method involves developing a model for future
Simulation returns and running multiple hypothetical tests through the model. It
enables calculating the expected loss and the variance related to
the losses and the probabilities associated with the maximum loss.

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Topic #2: Types of Enterprise Risk

Hazards Risk related to natural disasters such as storms, floods, etc.

Risk is caused by the inability to finance the business, including
Financial short-term (liquidity) and long-term (solvency). This risk can be
influenced by internal factors such as strategic decisions or external
factors such as global economic conditions.
Risk is related to the mix of fixed and variable costs in a company's
Operational cost structure. Risk increases with the proportion of fixed costs.
Operational risk can also arise from the internal process and system
failures, personnel, legal and compliance issues, and political
instability.
Strategic Risk related to planning and strategic decisions.
Business Risk Risk related to the fundamental viability of a business—the question
of whether a company will be able to make sufficient sales and
generate adequate revenues to cover its operational expenses and
turn a profit.

2.1 FINANCIAL RISK

Financial risk, as the term suggests, is the risk that involves financial loss to firms. Financial
risk generally arises due to instability and losses in the financial market caused by movements
in stock prices, currencies, interest rates, and more.

TYPES OF FINANCIAL RISK:

a) Market Risk
This type of risk arises due to the movement in prices of financial instruments. Market
risk can be classified as Directional Risk and Non-Directional Risk. Directional risk is
caused due to movement in stock price, interest rates, and more. Non-Directional risk,
on the other hand, can be volatility risks.

b) Credit Risk
Also known as default risk. This type of risk arises when an organization fails to fulfill its
obligations towards its counterparties. Credit risk can be classified into Sovereign Risk
and Settlement Risk. Sovereign risk usually occurs due to complex foreign exchange
policies. On the other hand, settlement risk arises when one party makes the payment
while the other party fails to fulfill the obligations.

c) Liquidity Risk
This type of risk arises out of an inability to execute transactions. Liquidity risk can be
classified into Asset Liquidity Risk and Funding Liquidity Risk. Asset Liquidity risk arises
either due to insufficient buyers or insufficient sellers against sell orders and buys
orders, respectively.

d) Legal Risk
This type of financial risk arises out of legal constraints such as lawsuits. Whenever a
company needs to face financial losses out of legal proceedings, it is a legal risk.

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 e) Asset-backed Risk
This type is the chance that asset-backed securities—pools of various types of
loans—may become volatile if the underlying securities also change in value.
Sub-categories of asset-backed risk involve the borrower paying off a debt early,
thus ending the income stream from repayments and significant changes in
interest rates.

f) Foreign Investment Risk

Investors holding foreign currencies are exposed to currency risk because different
factors, such as interest rate changes and monetary policy changes, can alter the
calculated worth or the value of their money. Meanwhile, changes in prices because of
market differences, political changes, natural calamities, diplomatic changes, or
economic conflicts may cause volatile foreign investment conditions that may expose
businesses and individuals to foreign investment risk.

2.2 OPERATIONAL RISK

"Operational Risks" is a risk that includes errors because of the system, human intervention,
incorrect data, or other technical problems. Every firm or individual has to deal with such an
operational risk in completing any task/delivery.
Operational risks may include:
a) System errors
b) Internal control errors
c) Product issues
d) Human errors
e) Improper management
f) Quality issues
In the case of individuals, we can drill it down to error because of self-process or other
technical problems.

2.3 STRATEGIC RISK

a) Industry Margin Squeeze
As industries evolve, a succession of changes can occur that threatens all companies
within that sector. One particular threat is that profit margins will be eroded for all
companies in that sector. The industry will become a no-profit zone from factors such as
overcapacity and commoditization. The best countermeasure for this margin squeeze is
shifting the compete/collaborate ratio among the firms. When the industry is growing,
and margins are large, companies can compete nearly on all fronts and ignore
collaboration. However, this 100 to zero ratio of competition to collaboration should
dramatically shift when the margins decline. Collaboration may include sharing back-
office functions, coproduction or asset-sharing agreements, purchasing and supply
chain coordination, joint R&D, and collaborative marketing.

b) Technology Shift
Technology risks can impact a company's performance. But the entrance of new
technology into the industry can make companies' products and services obsolete
quickly. For example, the film processing industry experienced a significant shift with
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 introducing digital imaging into a formerly film-based process. However, most firms don't
always know how and when technology will succeed in the marketplace. Risk managers
can double bet-that invest in two or more versions of technology simultaneously. Hence,
no matter which version prevails, the company comes out as a winner.

c) Brand Erosion
Brands are susceptible to an array of risks that can appear overnight and threaten to
destroy the brand. One of the most effective countermeasures to brand erosion is
redefining the scope of brand investment past marketing to other factors that affect a
brand, like service and product quality. Another countermeasure involves the continuous
reallocation of brand investment based on the early detection of weaknesses by
measuring the critical dimensions of the brand continuously.

d) Competitor
Competitors are the company's major sources of risk, whether from the threat of new
products or lower-cost structures. One of the most detrimental risks is the one-of-a-kind
competitor that emerges in the market and seizes most of the market share. Constantly
scanning the need for this type of competitor is crucial because the best response is to
change the business design once identified rapidly. This response allows a company to
minimize the strategic overlap from the competitor and establish a profitable position in
an adjacent marketplace.

e) Customer Priority Shift

One of the most significant risks associated with customers is the shift in customers'
preferences. Two effective countermeasures are the continuous creation and analysis of
proprietary information and fast and cheap experimentation. Ongoing innovation and
research enable companies to detect the next phase of customer preferences in the
industry. The quick and affordable experiment helps managers to determine the right
product variations to offer different customers fast. These approaches help companies
retain and grow their customer bases and increase revenue per customer and overall
profitability.

(Customer priority shift is another form of strategic risk. Customers' preferences can
change gradually or overnight without any prior notice to a company. To help
understand customers' preferences, companies need to create and analyze proprietary
information continuously. Also, companies should use fast and cheap experimentation
methods with customers. This helps companies identify the proper product variations to
offer to different customers.)

f) Project (New-Project Failure)

All projects face risks, but a new project faces the chance of not working correctly, not
attracting profitable customers, that competitors will copy it, or that it grows too slowly.
The best protection against these types of risk is to begin with an accurate assessment
of the project's chance of success before it is launched. The next step is to review past
projects' performances, both internally and externally. Three methods to help a company
systematically improve the project's odds of success are smart sequencing, developing
excess options, and employing the stepping-stone method. Smart sequencing means
launching the better-understood, more controllable projects first. Developing excess
opportunities while planning the project will also help to ensure the best one is used.
The stepping stone method involves creating a series of projects that lead from
uncertainty to success and make the ultimate project a success.

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g) Market Stagnation
Many companies have had their market value plateau or even decline because they
could not find new sources of growth. In order to counter this risk of stagnating volume
growth demand, innovation can be applied. This involves redefining a company's market
to expand the value offered to customers beyond product functionality. This could
reduce company costs, capital intensity, cycle time, and risk, improving profitability.

Risks are identified by bringing the team together; the organization has to bring together
the project team, board, stakeholders and discuss essential questions about the goals
and then jot down what can be the risky elements in the entire project. There is a need
to have open discussions on what could go wrong and what hindrances are most likely
to occur?

What kind of harm will it cause to the project? Can it be avoided or covered up? It is
crucial to identify the threats that come with the project and eventually find out the
opportunities that risks create and use it for its overall benefit.

-end-

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REFERENCES|
https://ebrary.net/12971/management/unexpected_loss
https://www.simplilearn.com/financial-risk-and-types-rar131-article
https://www.slideshare.net/SlideTeam1/risk-management-module-powerpoint-presentation-
slides
https://lukassen.wordpress.com/2011/05/05/types-of-strategic-risks/

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