Chapter 1 - Risk

Question 1

Risk main types:

Answer 1

• Upside
• Downside
• Two-way risk
• Speculative risk

Question 2

It is generally the case that firms must be willing to take higher risks if they want to achieve higher returns. Why the company should accept or avoid the risk?

Answer 2

• To generate higher returns, a business may have to take more risk in order to be competitive
• Conversely, not accepting risk tends to make a business less dynamic, and implies ‘follow the leader’ strategy
• Incurring risk also implies that the returns from different activities will be higher - ‘benefit’ being the return for accepting the risk
• Benefits can be financial - decreased cost, or intangible - better quality information
• In both cases, these will lead to the business being able to gain competitive advantage

Question 3

Draw the grid in terms of the risks a business can incur and the benefits from undertaking different activities:

Answer 3

1. Activity risk (X) (low) / Ability to gain competitive advantage (Y) (low) - Routine
2. XL / YH - Identify and develop
3. XH / YL - Avoid
4. XH / YH - Examine carefully

Question 4

CIMA’s Risk Management Cycle identifies various activities that should be undertaken during risk management. Identify the steps in the correct order:

Answer 4

1. Establish risk management group;
2. Identify risk areas;
3. Understand and assess scale of risk
4. Develop risk response strategy;
5. Implement strategy and allocate responsibilities
6. Implementation and monitoring of controls
7. Review and refine process and do it again

Question 5

Categories of risk

Answer 5

1. Political, legal and regulatory
2. Business risk
3. Economic risk
4. Financial risk
5. Technology risk
6. International risk
7. Fraud and employee malfeasance risk
8. Corporate reputation risk
9. Environmental risk

Question 6

Business risk types with definitions for each

Answer 6

1. Strategy risk - risk that business strategies will fail (e.g. acquisitions/product launches);
2. Product risk - risk of failure of new product launches/loss of interest in existing products
3. Commodity price risk - risk of a rise in commodity prices
4. Product reputation risk - risk of change in product’s reputation or image
5. Operational risk - risk that business operations may be inefficient or business may fail
6. Contractual inadequacy risk - risk that the terms of a contract do not fully cover a business against all potential outcomes
7. Fraud and employee malfeasance

Question 7

Which of the following would normally be classified as an operational risk? (select all that apply):

A the risk that a new product will fail
B The risk of competitors cutting costs by manufacturing overseas
C The loss of an experienced supervisor
D Raw materials being wasted during the production process due to untrained staff

Answer 7

C and D

Question 8

Which of the following would normally be classified as a strategic risk?

A Human error
B Information technology failure
C Fraud
D Stricter health and safety legislation

Answer 8

D

Question 9

Define Economic risk with examples

Answer 9

This is the risk that changes in the economy might affect the business. Those changes could be inflation, unemployment rates, international trade relations or fiscal policy decisions by government. Again, this risk is considered to be external to the business

Question 10

Define financial risk and list main types

Answer 10

Financial risk is a risk of a change in a financial condition such as an exchange rate, interest rate, credit rating of a customer, or price of a good.

The main types of financial risk are:

• Credit risk - risk of non-payment by customers
• Political risk - risk arising from actions taken by a government that affect financial aspects of the business
• Currency risk - risk of fluctuations in the exchange rate
• Risk that interest rates change
• Gearing risk - Risk in the way a business is financed (debt vs equity)

Question 11

Define technology risk

Answer 11

Technology risk is the risk that the technology changes will occur that either present new opportunities to businesses, or on the down-side make their existing processes obsolete or inefficient

Question 12

How fraud risk can be managed?

Answer 12

• Fraud prevention: ensuring that the opportunities to commit fraud are minimised
• Fraud detection and deterrence: detection measures are designed to identify fraud after it has occurred. If employees fear that the risk of detection is high, they will be deterred from trying to commit fraud.

Question 13

How corporate reputation risk could arise?

Answer 13

• environmental performance
• social performance
• health and safety performance

Question 14

Define malfeasance risk

Answer 14

Malfeasance risk means doing wrong or committing an offence. Organisations might be exposed to risks of actions by employees that result in an offence or crime (other than fraud). This, like fraud risk, is a type of operational risk

Question 15

List and define risks in international operations

Answer 15

1. Culture - A UK business may fail in a venture overseas because it does not adapt to the overseas culture
2. Litigation - there is a greater danger of litigation risk in overseas operations as the parent company management may not understand the legislation well and therefore have more risk of breaching it.
3. Credit - there is often a greater difficulty in controlling credit risk on overseas sales. Chasing debts is more difficult and expensive.
4. Items in transit - there is a greater risk of losses or damage in transit if companies are transporting good great distances
5. Financial risks - these include foreign exchange risks

Question 16

Risk identification and management are the responsibility of: (select all that apply)

A The board
B The risk manager
C Internal audit
D Non-executive directors

Answer 16

ALL. everybody is responsible for risk identification and management