Risk Management

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Strategic Management

Financial & Political Risk
David Warnock-Smith

Strategic Management

Programme
• • • • Introduction to “risk” and “risk management” Sources of risk Risk classification Overview and management of: – Financial risk – Political risk – (Business / operational risk)

Strategic Management

Risk - Definition “The fact that the results of any action are not certain, but may take more than one value. Risk is usually used to describe the form of uncertainty where, while the actual outcome of an action is not known, it is expected that it will be determined as the result of a random drawing from a set of possible outcomes whose distribution is known….” "risk" A Dictionary of Economics. John Black. Oxford University Press, 2002

Strategic Management

Risk Examples • “You can make a million in the airline business ……….

……… but only if you start with a billion!”
• Identify examples of risks faced by an airline

Strategic Management

Risk Parameters
Probability of Occurrence

Susceptibility to Change

Risk
Severity of Impact

Risk interdependence

Risk parameters (Allen 1995)
Strategic Management

Sources of Risk (Examples) • • • • Political Environmental Market Financial • • • • Project Criminal Safety Legal

General increase in risk levels Many examples of companies that have failed to manage risk Merna & Al-Thani, 2005 p15

Strategic Management

Risk Classification
• Business / Operational • Focuses on the risks a business takes to maximise shareholder wealth

• Financial

• “Unexpected changes in the value of the portfolio of assets / liabilities as a result of activities in financial markets or the value of financial instruments” • Concerns the fundamental changes in a country’s social, political or macroeconomic environment

• Political / Country

Strategic Management

Risk Management
• “a formal process that enables the identification, assessment, planning and management of risks” • Aim – Identify risk – Undertake an objective assessment of risks specific to the organisation – Respond to risks in an appropriate and effective manner • Should apply at all levels of an organisation (corporate, strategic business, project) Merna & Al-Thani, 2005 p2

Strategic Management

Risk Management Approaches
• • • • • • • Process controls / Operating procedures Portfolio approach Hedging Guarantees Insurance Company structure & joint ventures Contractual arrangements

• Key element of Corporate Governance “The board’s role is to provide entrepreneurial leadership of the company within a framework of prudent and effective controls which enables risk to be assessed and managed.” The Combined Code, 2003

Strategic Management

Financial Risk: Examples

• Impact on the value of an organisation as a result of changes in: – Equity Prices – Exchange rates – Interest rates – Commodity prices

Strategic Management

Equity Market Volatility
• 1700’s – South Sea Bubble • 1929 – Stock Market Crash – DJ 400 to 145 in 3 days • 1987 – “Black Monday” – DJIA - 22.6% – HSI - 45.8% – FTSE - 26.4% • 1997 Far East Stock Market Crash – South Korea – 60% in 3 months FTSE 100 -2008

2008 Market Falls • Shanghai - down 65.2% • Hong Kong - down 48.3% • Paris - down 42.7% • Frankfurt - down 40.4% • New York - down 33.84% • London - down 31.3% Dow Jones I A - 2008

Strategic Management

FTSE 100 past12 months

Exchange Rate Volatility
• Increasingly volatile since collapse of Bretton Woods fixed exchange rate system in 1970’s • Dramatic currency movements during the financial crisis

2008 £/US$
£/ US$

2010
Strategic Management

2009

Exchange Rate Risk
Sterling challenge for UK shops (2009) • Next warned that a coming headache would be a massive increase in costs caused by the sharp devaluation of sterling. • In Next's case this didn’t bite until the autumn and winter of 2009, because it hedged its currency exposure until then. For most big...
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