RISK ANALYSIS AND MANAGEMENT
MAY 2011 RAM DRAFT MODEL SOLUTIONS BY GRACIOUS CHANGAYA
1.1
Below is one of the myths surrounding the concept of risk:
a) Risk is bad *
b) Risk can be hedged
c) Risk can be calculated
d) Risk can be mitigated
1.2
Risk can arise from:
a) Good management.
b) Adverse actions of other countries*
c) Good weather
d) Great decisions
1.3
The general rule in any business is for:
a) The benefit to outweigh the costs*
b) The benefit to equal the costs
c) The costs to outweigh the rewards
d) The rewards to outweigh the benefits
1.4
Any costing of risks must take into account the following;
a) Direct costs
b) Indirect costs
c) Technical costs factors
d) All of the above*
1.5
Listed below is one example of financial risk:
a) Currency fluctuations*
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b) Fraud/embezzlement
c) Gearing/capitalization
d) All of the above
1.6
Examples of areas of focus for Strategic risk management are:
A. Fraud controls
B. Tidal waves
C. Capital adequacy*
D. Erosion
1.7
Systematic risk is sometimes referred to as:
a) Political
b) Market risk*
c) Predictable risk
d) Social risk
1.8
The types and degree of risks organizations may be exposed to depend upon a
number of factors such:
a) Size and volume
b) Complexity and nature of business
c) Business activities
d) All of the above*
1.9
Internal financial risks are those that;
a) Are beyond your control
b) Cannot be managed
c) Include liquidity risks*
d) Originate from environmental factors
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1.10
Operational risk is defined as the risk of loss resulting from:
a) Strategic risk
b) Reputational risk
c) Legal risk*
d) Earthquake
1.11
Organizational views of risk seem to move through four increasing levels of
sophistication:
a) Awareness, Engineering, Comparative and Training
b) Technology, Awareness, Engineering and Comparative
c) Engineering, Awareness, Management and Comparative
d) Awareness, Engineering, Comparative and Embedded*
1.12
The most common determinant that affect people’s perception over risk are:
a) Fear of something, cognitive bias and control we believe in us. *
b) Fear of the dark, fling, spiders, getting into debt and making profits
c) All of the above
d) A only
1.13
Why should banks be concerned with their liquidity positions?
a) Signaling to the wider market that banks make losses as well
b) Helps to increase the risk premium that a bank has to pay on its borrowed
funds.
c) Ensuring that some of the bank's lending commitments are not met.
d) Avoiding forced sale of the bank's assets. *
1.14
The five Cs of credit are;
a) Cash, Capability, Capacity, Capital and Collateral
b) Conditions, Capacity, Capital, Character and Collateral*
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c) Capability, Collateral, Capacity, Capital and Creditworthiness
d) Capital, Character, Creditworthiness, Capacity and Conditions
e) Collateral, Capacity, Character, Capability & Cash
(Total 15 marks)
QUESTION 2
Financial Loss
If your house burns down and you are uninsured, then you will lose the value of
the property plus your contents (less the site value).
Reputation or Brand
If there is an adverse report about your product or operating practices, then your
reputation or your brand may be impaired (e.g. Benzene in Perrier), which may
take time to recover or destroyed e.g. Arthur Andersen (see below).
Opportunity cost
A company’s sales may be affected by an incident, which although it does not cost
you anything in terms of losses, generates an opportunity cost from sales not
made. A good example is if your shop or factory or bank branch is destroyed, you
may well receive the capital value from insurance but the transactions that you
would have made are lost.
Physical cost
This can include personal injury and damage to property \ goods etc – e.g. if you
are in a car crash, then you may be injured and \ or lose an eye or a leg. You
accept this chance, as the probability is low and you do not expect to be a victim.
Emotional cost
If you are in a car crash then you might suffer shock, or you might experience
trauma at the loss of a loved one riding as a passenger in your car. If your house
is burgled then the loss of some items may well cause you greater emotional cost
than the tangible value – e.g. if wedding photos, educational certificates or videos
are taken or destroyed.
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Competitive Edge
If you take the wrong decisions, then you will become uncompetitive, due to poor
products, inadequate systems, wrong staff etc.
QUESTION 3
a)
Three methods for calculating risk as provided by Basel 2 are:
3 marks
Basic indicator approach (BIA):
Standardized approach:
Advanced measurement approach (AMA):
b)
Briefly explain the four objectives of Basel 2
12 marks
The basic objectives of Basel 2 are as follows:

to continue to promote safety and soundness in financial systems through
the maintenance of at least the same current overall level of capital in the
system;

to continue to promote competitive equality;

to constitute a more comprehensive approach towards addressing risks;

to provide approaches to capital adequacy that are appropriately sensitive
to the degree of risk involved in a bank's positions and activities;

and to focus on internationally active banks, although the underlying
principles should be suitable for application to banks of varying levels of
complexity and supervision.
(Total 15 marks)
QUESTION 4
Why do central banks legislate operations of financial institutions in their
respective countries? Briefly discuss five reasons.
Students to tackle;
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 Protection
 To maintain the soundness of financial institutions
 To ensure proper behavior by corporations
 Financial stability
 To reduce criminal activity
 To ensure proper accountability
 To give a level playing field
(Total 15 marks)
SECTION B
QUESTION 5
a)
Briefly describe the process of managing risk
8 marks
The process of managing risk is a process of:

Getting an understanding of the likelihood of events occurring which will
affect you adversely

Whether to accept them or not

If so - how much will you accept

What to do about minimizing the potential damage (loss)

Or preparing for action – contingencies and disaster recovery – in the
event that they occur

What is risk –i.e. definitions the types and how they occur in theory

Understanding risks and what methods to use to analyze them
Managing risks: the practicalities and how to use the analysis and your
understanding of risks to take appropriate action.
b)
What are the different sources of risk? Discuss four sources.
12 marks
External factors
Inherent features of the business
Stakeholders expectations (like investors, customers, government)
treasury operations
changes in environment
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technological advances
product obsolescence
external events.
2 marks each
(Total 20 marks)
QUESTION 6
What are the key components of risk management program? Discuss four
components.
Risk identification
In order to properly manage risks, an institution must recognize and understand
risks that may arise from both existing and new business initiatives; for example,
risks inherent in lending activity include credit, liquidity, interest rate and
operational risks. Risk identification should be a continuing process, and should be
understood at both the transaction and portfolio levels.
Risk Measurement
Once risks have been identified, they should be measured in order to determine
their impact on the banking institution’s profitability and capital. This can be done
using various techniques ranging from simple to sophisticated models. Accurate
and timely measurement of risk is essential to effective risk management systems.
An institution that does not have a risk measurement system has limited ability to
control or monitor risk levels. Banking institutions should periodically test their risk
measurement tools to make sure they are accurate. Good risk measurement
systems assess the risks of both individual transactions and portfolios.
Risk Monitoring
Institutions should put in place an effective management information system (MIS)
to monitor risk levels and facilitate timely review of risk positions and exceptions.
Monitoring reports should be frequent, timely, accurate, and informative and
should be distributed to appropriate individuals to ensure action, when needed.
Risk Control
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After measuring risk, an institution should establish and communicate risk limits
through policies, standards, and procedures that define responsibility and
authority. These limits should serve as a means to control exposure to various
risks associated with the banking institution’s activities. Institutions may also apply
various mitigating tools in minimizing exposure to various risks. Institutions should
have a process to authorize and document exceptions or changes to risk limits
when warranted.
(Total 20 marks)
QUESTION 7
Explain five components of effective credit risk management.
Students to discuss
active board and senior management oversight;
sufficient policies, procedures and limits;
adequate risk measurement, monitoring and management
information systems;
and comprehensive internal controls.
(Total 20 marks)
QUESTION 8
Describe any five principles stipulated under the ‘ Principles of sound corporate
governance’ which the Basel Committee identified as key principles.
Principle 1
Board members should be qualified for their positions, have a clear understanding
of their role in corporate governance and be able to exercise sound judgment
about the affairs of the bank.
Principle 2
The board of directors should approve and oversee the bank’s strategic objectives
and corporate values that are communicated throughout the banking organisation.
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Principle 3
The board of directors should set and enforce clear lines of responsibility and
accountability throughout the organisation.
Principle 4
The board should ensure that there is appropriate oversight by senior
management consistent with board policy.
Principle 5
The board and senior management should effectively utilise the work conducted
by the internal audit function, external auditors, and internal control functions.
Principle 6
The board should ensure that compensation policies and practices are consistent
with the bank’s corporate culture, long-term objectives and strategy, and control
environment.
Principle 7
The bank should be governed in a transparent manner.
Principle 8
The board and senior management should understand the bank’s operational
structure, including where the bank operates in jurisdictions, or through structures,
that impede transparency (i.e. “know-your-structure”).
(Total 20 marks)
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