H&N, ch. 1 1

Chapter OutlineChapter Outline1.11.1 RISKRISK

Different Meanings of RiskDifferent Meanings of RiskBusiness RiskBusiness Risk

Price RiskPrice RiskCredit RiskCredit RiskPure RiskPure Risk

Comparison of Pure Risk and Its Management with Other Types of RiskComparison of Pure Risk and Its Management with Other Types of Risk

1.21.2 RISK MANAGEMENTRISK MANAGEMENTThe Risk Management ProcessThe Risk Management ProcessLosses from Pure RiskLosses from Pure RiskRisk Management MethodsRisk Management Methods

Loss ControlLoss ControlLoss FinancingLoss FinancingInternal Risk ReductionInternal Risk Reduction

Selecting Risk Management Methods to Increase Firm ValueSelecting Risk Management Methods to Increase Firm Value

1.31.3 RISK MANAGEMENT ORGANIZATIONRISK MANAGEMENT ORGANIZATION

H&N, ch. 1 2

What is Risk?What is Risk? Two Important Meanings of RiskTwo Important Meanings of Risk

H&N, ch. 1 3

Major Types of Business RiskMajor Types of Business RiskF ig u re 1 -1 M ajor Typ es of B u s in ess R isk

Output Price Risk Input Price Risk

Commodity Price Risk

Exchange Rate Risk

In terest Rate Risk

P rice R isk C red it R isk

Damage to Assets

Legal Liab ility

W orker In ju ry

Employee Benefits

P u re R isk

H&N, ch. 1 4

Pure Risk versus Other Types of Pure Risk versus Other Types of RiskRisk

– GeneralizationsGeneralizations::

» Pure risk Pure risk

» Price risk Price risk

» Pure risk Pure risk

» Price risk Price risk

» Pure risk involves Pure risk involves

» Price risk involves Price risk involves

H&N, ch. 1 5

The Risk Management ProcessThe Risk Management Process(1) (1)

(2) (2)

(3) (3)

(4) (4)

(5) (5)

H&N, ch. 1 6

Losses from Pure Risk (Figure 1-Losses from Pure Risk (Figure 1-2)2)

Dam age to Assets

In ju ry & Illness toEm ployees

Liab ility C laim s &Defense Costs

D irect L osses

Loss of Norm al Profit(net cash flow)

Continu ing & ExtraO perating Expense

Higher Cost of Funds& Foregone Investm ent

Bankrup tcy Costs(legal fees)

In d irect Losses

H&N, ch. 1 7

Major Risk Management Methods (Figure 1.3)Major Risk Management Methods (Figure 1.3)

Reduced Level ofRisky Activity

IncreasedPrecau tions

L oss C on tro l

Retention &Self-Insurance

Insu rance

Hedg ing

O ther ContractualRisk Transfers

L oss F in an c in g

Diversification

Investm en ts inIn form ation

In tern a l R isk R ed u c tion