Chapter 01

Risk Management
 What is Risk?
• The change of any financial loss of an asset is
called risk.
• According to John. J. Hampton “Risk may be
defined as the likelihood that actual return
from an investment will be less than expected
return.
 What is Risk?
• Risk is the possibility of loss.
• Risk is the uncertainty of future loss.
• Risk is the possibility of an unfortunate
occurrence.
• Risk is the unpredictability of happening of an
untoward event.
• Risk is the combination of hazards.
 Risk Related Terms
• Chance: refer to the probable advantageous,
desirable or profitable outcome of a fortuitous
event. For example chance of passing an
examination or chance of not failing an
examination.
• Risk: refer to the probable disadvantageous,
undesirable or unprofitable outcome of a
fortuitous event. For example risk of death.
• Probability: refer to neutral mathematical
quantitative expression of an unforeseen or
fortuitous event.
 Risk Related Terms
• Perils- refer to the cause of loss or the
contingency that may cause a loss.
• Hazard- Hazard are the conditions that
increase the severity of loss .
 Elimination and Spreading Risk and
Method of Risk Management
• Risk Avoidance: This involves selection of
those business activities only which have
minimum amount of risk.
• Risk Prevention: This can be done when-
1. Eliminating the cause of loss and protecting
loss of things or person exposed to damage
or injury
2. Minimizing the loss when it at all occurs.
 Elimination and Spreading Risk and
Method of Risk Management
• Risk Assumption: refers to individual or firm
assuming the risk itself and bearing the
ensuring uncertainty.
• Risk Distribution: This involves spreading risks
by means of group sharing such as partnership
or company form of business organization.
• Hedging and neutralization: This involves
offsetting loss from the occurrence of a risk by
a compensating gain from another activity.
 Elimination and Spreading Risk and
Method of Risk Management
• Elimination of Risk: It is illogical to spread
risks that can be eliminated entirely.
• Risk Transfer: This refers to one person
guaranteeing another against the risk of loss.
 Classification of Risks
• Financial vs. non-financial risks.
• Pure and speculative risks
• Fundamental and particular risks.
 Financial risks vs. Non Financial risks
• Financial risks:
• These are the risks where the outcome of an
event can be measured in monetary terms.
The loss can be assessed and a proper
monetary value can be given to those losses.
• Examples are-
• Material damage to property arising out of a
event. Damage to motor cycle.
 Financial risks vs. Non Financial risks
• Theft of property which may be motor car,
machineries, cash and item of household.
• Loss of profit of a business due to fire damaging
the material property.
• Personal injuries due to industrial, road or other
accidents.
• Death of a bread winner in a family leading to
corresponding financial hardship.
• These losses can be replaced, reinstated or
repaired or even a corresponding financial
support can be brought about.
 Financial risks vs. Non Financial risks
• Non financial risks: These are the risks which
outcomes can not be measured in monetary
terms.
• Examples can be-
• Choice of car , its brand or color.
• Selection of a restaurant menu.
• Choice of bride.
• Career selection etc.
 Pure risks vs. Speculative risks
• Pure risks are those risks where the outcome
shall result into loss only or at best a break
even situation.
• The result is always unfavorable or may be the
same situation has remained without giving
birth to a profit.
• Examples-
• Cyclone damage possibility to the factory
building.
 Pure risks vs. Speculative risks
• Fire damage possibility to stock
• Theft possibility to removable items
• Pure risks are insurable.
 Pure risks vs. Speculative risks
• Speculative risks are those risks where there
is the possibility of gain and profit. At least the
intention is to make a profit and no loss.
• Examples
• The question of withdrawal quota system
• The question of credit sale.
• These risks are usually not insurable.
 Fundamental vs. Particular risks
• Fundamental risk are the risks which arise from
causes that are beyond the control of an
individual group of individuals.
• Examples are-
• Flood, cyclone etc.
• Earthquake, Tsunami
• Draught etc.
• Fundamental risks were not supposed to be
insurable because of magnitude and these are
the responsibility of the state.
 Fundamental vs. Particular risks
• Particular risks may be identified as causes
arising from personal behavior and effects not
being of that magnitude. These are mostly man
created because of their negligence, error in
judgment, carelessness, disregard for law or
respect.
• Examples are-
• Fire, explosion, machinery breakdown.
• Collapse of bridge, burglary, motor accident etc.