P1.T1.300. Definition of risk

[Suzanne Evans]

AIMs: Define risk, identify the classifications of risks, and explain the role played by risk in value creation. Describe a risk profile and explain how one is created.

Questions:

300.1. You attend a Board meeting devoted to reviewing a firm's proposed risk profile. Your fellow Director Bob, who is both talkative and a bit philosophical, makes the following statements about risk:

I. Risk is not the experience of a loss or reduction in value. Rather, risk is the possibility of, or potential for, the occurrence of a loss.
II. The Chinese symbol for crisis offers a good description of risk because it reminds us that risk is both a threat (danger) and an opportunity
III. A firm's risks are all the uncertainties that the Directors would like to either eliminate, or at the very least minimize
IV. Risk is uncertainty where at least one of the outcomes is undesirable but at least approximately measurable

According to the World Bank's International Finance Corporation (IFC), which of Bob's assertions are true?

a. None, Bob really should sit for the FRM
b. II. and III. only
c. I., II. and IV.
d. All are true, Bob must be a certified FRM

300.2. According to the IFC, after the Directors have created a firm's risk profile, "the next step is to divide the firm's various risks into three [mutually exclusive] groups." Which of the following is NOT one of the three groups?

a. Risk that should be allowed to pass through the firm to its owners
b. Risk that should be hedged
c. Risk that should be exploited
d. Risks that should be monitored

300.3. In the case of a Brazilian Airline, which of the following risks is LEAST likely to appear in the firm's risk profile?

a. Oil price changes as a market risk
b. Board-level strategy decisions as an operational risk
c. Aircraft breakdowns as an operational risk
d. Exchange rate fluctuations as a financial risk

Answers:

• Here in forum

 

[ABFRM]

300.1 ----> c
300.2 ----> d
300.3 ----> b

 

[Gerard Chan]

What is the meaning of risk profile?

 

[David Harper CFA FRM]

CLJ,

It is (effectively) a new term in the FRM by virtue of mention in the first Foundations reading, see here (freely available). I think according to the IFC, the motivation of a risk profile is ensure that the Directors are explicitly and specifically aware of a firm's various risks (if we think about some of the risk failure case studies, Board-level "ignorance" is often cited). From the IFC:

"A major step in appropriate oversight of risk taking by a firm is listing out all of the risks that a firm is potentially exposed to and categorizing these risks into groups. This list is called a risk profile.

Do most firms create risk profiles? Not necessarily. In many firms, it is taken for granted that most everyone in the firm (particularly those with experience) is already aware of the risks that the firm faces. This can be a mistake and more so with risks that are uncommon, since many managers may never have experienced that risk. For boards and across firms as a whole it is useful to be clear and explicit about the risk faced. Instead of assuming awareness, make sure that everyone understands by spelling out the potential risks."