Tag: University of Mumbai BMS Notes

An actuary is a business professional who deals with the measurement and management of risk and uncertainty. The name of the corresponding field is actuarial science. These risks can affect both sides of the balance sheet and require asset management, liability management, and valuation skills. Actuaries provide assessments of financial security systems, with a focus on their complexity, their mathematics, and their mechanisms.

While the concept of insurance dates to antiquity, the concepts needed to scientifically measure and mitigate risks have their origins in the 17th century studies of probability and annuities. Actuaries of the 21st century require analytical skills, business knowledge, and an understanding of human behavior and information systems to design and manage programs that control risk.[6] The actual steps needed to become an actuary are usually country-specific; however, almost all processes share a rigorous schooling or examination structure and take many years to complete.

The profession has consistently been ranked as one of the most desirable.[8] In various studies, being an actuary was ranked number one or two multiple times since 2010 and in the top 20 for most of the past decade.

An actuary is a professional who specialises in the field of analysing financial risks by implementing statistical, financial and mathematical theories. In insurance, actuaries aid in assessing risks which help companies in the estimation of premiums for their policies.

Role of an Actuary in an Insurance Company

It is ideal for insurance companies to create policies that bear minimal risk and can generate stable returns. Estimating risk and return from each proposal also in turn aids in assuring policyholders that their claims will be settled.

With regards to insurance, actuarial practices involve analysing factors related to a customer’s life expectancy, construction of mortality tables that help one to have a measurement of predictability and offering insight to brokers.

Actuarial science mostly finds its application in the life insurance mortality analysis. However, they can also be applied in case of other general insurance fields like property and liability insurance.

Sometimes recommendations for the determination of premium for insurance policies made by actuaries can also have a positive impact on the behaviour of policyholders. For instance, premium payable by non-smokers for life insurance policies is often significantly lesser than that for smokers. This might push individuals to quit smoking to avail their life insurance policies at a lower premium.

Responsibilities

Actuaries use skills primarily in mathematics, particularly calculus-based probability and mathematical statistics, but also economics, computer science, finance, and business. For this reason, actuaries are essential to the insurance and reinsurance industries, either as staff employees or as consultants; to other businesses, including sponsors of pension plans; and to government agencies such as the Government Actuary’s Department in the United Kingdom or the Social Security Administration in the United States of America. Actuaries assemble and analyze data to estimate the probability and likely cost of the occurrence of an event such as death, sickness, injury, disability, or loss of property. Actuaries also address financial questions, including those involving the level of pension contributions required to produce a certain retirement income and the way in which a company should invest resources to maximize its return on investments in light of potential risk. Using their broad knowledge, actuaries help design and price insurance policies, pension plans, and other financial strategies in a manner that will help ensure that the plans are maintained on a sound financial basis.

Expected claim cost: Claim cost must be paid by the insurer for a contract or group of contracts. This cost represents the largest component of the fair premium for most types of insurance.

1. Homogeneous buyers: When a there is existed a large number or group of insurance buyers and each buyer has the same loss distribution then the buyers are said to be homogeneous. For example, among a group of buyer each buyers has a 0.15 probability of loss taka 1000 and 0.85 probability of having no loss. Here assume that is buyers each buyers loss is independent of the loss of other buyers. As we seen that a large number of homogeneous insurances can charge a premium equal to the expected claim cost and be able to cover to its claim costs. Thus a fundamental of insurance premiums is the expected claim cost. If the insurer charged less then the expected claim cost average claim cost would exceed average revenues. On the other hand, competitor keeps the insurer from charging the more than the expected claim cost.
2. Heterogeneous buyers: When there are existed two groups of consumers with different loss distribution then the groups are called heterogeneous buyers.

Risk classification the process by which insurers estimate the expected claim cost for different buyers and changed premiums that vary according to expected claim costs. Buyers in risk classes with higher expected claim costs are charged higher rates. Insurers have strong incentives to classify buyers based on all information that helps predict differences in claim costs across buyers provided that the information can be obtain at a sufficiently low cost.

2. Investment income: Given the ability of insurers to earn investment income on premiums prior to the payment of claims the fair premium reflects the discounted value of expected claims costs .As a result the fair premium is inversely related to the level of interest rates and to the length of the claims.
3. Administrative costs: The fair premium includes an expense loading to cover the insurer’s administrative costs including both underwriting expenses and loss adjustment expenses.
4. Fair profit loading: The fair premium includes a profit loading to compensate investors for the disadvantages like double taxation of investment returns of investing in an insurance company other thing being equal. The fair profit loading is higher for lines of insurance with more uncertainty concerning future claim costs because the insurer needs to hold more capital to achieve a given probability of insolvency.

The risk assessment matrix will help your organization identify and prioritize different risks, by estimating the probability of the risk occurring and how severe the impact would be if it were to happen.

A risk assessment matrix is a common tool used by organizations of all sizes for three major reasons:

• To measure the size and scope of risk
• To determine if they have the appropriate resources to minimize the risk
• To triage and prioritize the list of risks in a legible, easy-to-read matrix

The risk assessment matrix can help identify risks at a widespread scope of a company at the enterprise, business process, and individual process level.

The risk assessment process in 4 steps 

The risk assessment process may seem like an intimidating process. But I’d like to offer a simplified view without a bunch of mathematical computations. 

The process:

• Identify the risk universe
• Determine the risk criteria
• Assess the risks
• Prioritize the risks

Step 1: Identifying the risk universe 

The goal with this first step is to capture the full scope of the present risk.

To start off, you’ll want to make sure you cast as wide a net as possible. The most effective way to do this is with free-flow brainstorming sessions. These brainstorming sessions will generate a list of ideas that will serve as the foundation of the risk assessment matrix. 

Now, let’s get the creative juices flowing!

From my own personal experience, I like to start with high-level risk categories that align to business functions, and then drill down to specific processes within those functions. This helps me narrow the focus down after a broad brainstorming session.

Additionally, your risk universe will contain concerns specific to your industry, along with concerns unique to your company.

Here’s one way that I would organize my risks: 

• Strategic: Increased competition
• Operational: Lack of available resources
• Financial: Cost of capital
• Market: Social media presence
• Technology: Data security

Step 2: Determining the risk criteria

Before assessing each risk, you’ll want to develop a common set of factors to help evaluate your organization’s risk universe.

A typical risk assessment matrix uses two main criteria:

• Likelihood (the level of possibility)
• Consequence (the level of impact)

However, some organizations may add other factors such as vulnerability and speed of onset. This is a critical step, as these criteria will drive the discussions throughout the rest of the process.

Beware of underestimating the importance of reaching consensus on the criteria. After all, you can’t manage what you can’t measure.

Step 3: Assessing the risks

This next step is where things start to get fun. (Well, as fun as a risk assessment matrix can be.) We’re going to assess the risks based on the criteria we laid out in the previous steps. 

If the identification step was qualitative in nature, this step includes a quantitative analysis of the most important risks. 

Most organizations use a common, three-part “High, Medium, and Low” scale at this stage, but taking a more granular approach could be beneficial to your organization expanding the scale to “1–5,” for instance.

Step 4: Prioritizing the risks

In the last step, we’re going to compare the different levels of risk (from step three) to the target risk criteria (from step two). In other words, prioritizing risk accounts for the impact, possibility, and importance of the risk, and outputs a plan.

If these last two steps sound subjective that’s because they are. Expert judgment is involved in risk assessment and prioritization techniques to identify potential impacts, define inputs, and interpret the data. 

Step 1: Establish an Enterprise Risk Structure

ERM requires the whole organisation to identify, communicate and proactively manage risk, regardless of position or perspective. Everyone needs to follow a common approach, which includes a consistent policy and process, a single repository for their risks and a common reporting format. However, it is also important to retain existing working practices based on localised risk management perspectives as these reflect the focus of operational risk management.

The corporate risk register will look different from the operational risk register, with a more strategic emphasis on risks to business strategy, reputation and so on, rather than more tactical product, contract and project focused risks. The health and safety manager will identify different kinds of risks from the finance manager, while asset risk management and business continuity are disciplines in their own right. ERM brings together risk registers from different disciplines, allowing visibility, communication and central reporting, while maintaining distributed responsibility.

In addition to the usual vertical risk registers, such as corporate, business units, departments, programmes and projects, the enterprise also needs horizontal, or functional risk registers. These registers allow function and business managers, who are responsible for identifying risks to their own objectives, to identify risks arising from other areas of the organisation.

The enterprise risk structure should match the organisation’s structure: the hierarchy represents vertical (executive) as well as horizontal (functional and business) aspects of the organisation.

This challenges the conventional assumption that risks can be rolled up automatically, by placing horizontal structures side by side with vertical executive structures. Risks should be aggregated using a combination of vertical structure and horizontal intelligence. This is a key factor in establishing ERM.

Step 2: Assign responsibility

Once an appropriate enterprise risk structure is established, assigning responsibility and ownership should be straightforward. Selected nodes in the structure will have specified objectives; each will have an associated manager (executive, functional or business), who will be responsible for achieving those objectives and managing the associated risks. Each node containing a set of risks, along with its owner and leader, is a Risk Management Cluster. *

Vertical managers take executive responsibility not only for their cluster risk register, but also overall leadership responsibility for the Risk Management Clusters below. Responsibility takes two forms: ownership at the higher level and leadership at the lower level. For example, a programme manager will manage his programme risks, but also have responsibility for overseeing risk within each of the programme’s projects.

Budgetary authority (setting and using Management Reserve), approval of risk response actions, communication of risk appetite, management reporting and risk performance measures are defined as part of the Owner and Leader roles as illustrated in Figure 3. This structure is also used to escalate and delegate risks.

Horizontal managers take responsibility for their own functional or business Risk Management Clusters, but also for gathering risks from other areas of the Enterprise Risk Structure related to their discipline. For example, the HR functional manager will be responsible for identifying common skills shortfall risks to bring them under central management. Similarly, the business continuity manager will identify all local risks relating to use of a test facility and manage them under one site management plan.

Step 3: Create an enterprise risk map

Risk budgeting and common sense dictate that risks should reside at their local point of impact, because this is where attention is naturally focused. However, the risk cause, mitigation or exploitation strategy may come from elsewhere in the organisation and often common causes and actions can be identified. In this case, we take a systemic approach, where risks are managed more efficiently when brought together at a higher level. To achieve this, we need to be able to map risks to different parts of the risk management structure.

To create an enterprise risk map, you need:

• A set of global categories to communicate information to the right place
• The facility to define the relationships between risks (parent, child, sibling etc)
• Scoring systems with consistent common impact types

Global categories

Functional and business managers should use these global categories to map risks to common themes, such as strategic or business objectives, functional areas and so on. These categories then provide ways to search and filter on these themes and to bring common risks together under a parent risk.

Step 4: Decision making through enterprise risk reporting

The most important aspect of risk management is carrying out appropriate actions to manage the risks. However, you cannot manage every identified risk, so you need to prioritise and make decisions on where to focus management attention and resources. The decision making process is underpinned by establishing risk appetite against objectives and setting a baseline, both of which should be recorded against each Risk Management Cluster®.

Enterprise-wide reporting allows senior managers to review risk exposure and trends across the organisation. This is best achieved through metrics reports, such as the risk histogram. For example, you might want to review the risk to key business objectives by cluster. Or how exposed different contracts and projects are to various suppliers.

Furthermore, there is a need to use a common set of reports across the organisation, to avoid time wasted interpreting unfamiliar formats. Such common reports ensure the risk is communicated and well understood by all elements of the organisation, and hence provide timely information on the current risk position and trends, initially top-down, then drilling down to the root cause.

Step 5: Changing culture from local to enterprise

At all levels of an organisation, changing the emphasis from ‘risk management’ to ‘managing risks’ is a challenge; however, across the enterprise it is particularly difficult. It requires people to look ahead and take action to avert (or exploit) risk to the benefit of the organisation. It also requires the organisation to encourage and reward this change in emphasis.

Unfortunately, problem management (fire-fighting) deals with today’s problems at the expense of future ones. This is generally a far more expensive process as the available remedies are limited. However, if potential problems are identified (as risks) before they arise, you have far more options available to affect a ‘Left Shift: from a costly and overly long process to one better matching the original objectives set!

Most organisations have pockets of good risk management, many have a mechanism to report ‘top N’ risks vertically, but very few have started to implement horizontal, functional or business risk management. Both a bottom up and top down approach is required. An ERM initiative should allow good local practices to continue, provided they are in line with enterprise policy and process (establishing each pocket of good risk management as a Risk Management Cluster will provide continuity).

From a top-down perspective, functional and business focused risk management needs to be kick started. A risk steering group comprising functional heads and business managers is a good place to start. The benefits of such a group getting together to understand inter-discipline risk helps break down stove-piped processes. This can trigger increasingly relaxed cross-discipline discussions and focus on aligning business and personal objectives that leads to rapid progress on understanding and managing risk.

Finally, to ensure that an organisational culture shift is affected, the senior management must be engaged. This engagement is not only aimed at encouraging them to see the benefits of managing risk, but to also help the organisation as a whole see that proactive management of risk (the Left Shift principle) is valued by all.

Enterprise risk management (ERM) is a plan-based business strategy that aims to identify, assess, and prepare for any dangers, hazards, and other potentials for disaster both physical and figurative that may interfere with an organization’s operations and objectives.

Enterprise risk management (ERM) in business includes the methods and processes used by organizations to manage risks and seize opportunities related to the achievement of their objectives. ERM provides a framework for risk management, which typically involves identifying particular events or circumstances relevant to the organization’s objectives (threats and opportunities), assessing them in terms of likelihood and magnitude of impact, determining a response strategy, and monitoring process. By identifying and proactively addressing risks and opportunities, business enterprises protect and create value for their stakeholders, including owners, employees, customers, regulators, and society overall.

ERM can also be described as a risk-based approach to managing an enterprise, integrating concepts of internal control, the Sarbanes–Oxley Act, data protection and strategic planning. ERM is evolving to address the needs of various stakeholders, who want to understand the broad spectrum of risks facing complex organizations to ensure they are appropriately managed. Regulators and debt rating agencies have increased their scrutiny on the risk management processes of companies.

According to Thomas Stanton of Johns Hopkins University, the point of enterprise risk management is not to create more bureaucracy, but to facilitate discussion on what the really big risks are.

The discipline not only calls for corporations to identify all the risks they face and to decide which risks to manage actively, but it also involves making that plan of action available to all stakeholders, shareholders and potential investors, as part of their annual reports. Industries as varied as aviation, construction, public health, international development, energy, finance, and insurance all utilize ERM.

Companies have been managing risk for years. Historically, they’ve done this by buying insurance: property insurance for literal, detrimental losses due to fires, thefts, and natural disasters; and liability insurance and malpractice insurance to deal with lawsuits and claims of damage, loss, or injury. But another key element in ERM is a business risk that is, obstacles associated with technology (particularly technological failures), company supply chains, and expansion and the costs and financing of the same.

More recently, companies have managed such risks through the capital markets with derivative instruments that help them manage the ups and downs of moment-to-moment movements in currencies, interest rates, commodity prices, and equities. From a mathematical point of view, all of these risks or “exposures” have been reasonably easy to measure, with resulting profits and losses going straight to the bottom line.

Modern businesses, however, face a much more diverse collection of obstacles and potential dangers. How companies manage the risks that defy easy measurements or a framework for management also falls under the ERM umbrella. These potentials for exposure include crucial risks such as reputation, day-to-day operational procedures, legal and human resources management, financial, the risk of failure of internal controls systems related to the Sarbanes-Oxley Act of 2002 (SOX), and overall governance.

ERM frameworks defined

There are various important ERM frameworks, each of which describes an approach for identifying, analyzing, responding to, and monitoring risks and opportunities, within the internal and external environment facing the enterprise. Management selects a risk response strategy for specific risks identified and analyzed, which may include:

• Avoidance: exiting the activities giving rise to risk
• Reduction: taking action to reduce the likelihood or impact related to the risk
• Alternative Actions: deciding and considering other feasible steps to minimize risks
• Share or Insure: transferring or sharing a portion of the risk, to finance it
• Accept: no action is taken, due to a cost/benefit decision

Monitoring is typically performed by management as part of its internal control activities, such as review of analytical reports or management committee meetings with relevant experts, to understand how the risk response strategy is working and whether the objectives are being achieved.

In 2003, the Casualty Actuarial Society (CAS) defined ERM as the discipline by which an organization in any industry assesses, controls, exploits, finances, and monitors risks from all sources for the purpose of increasing the organization’s short- and long-term value to its stakeholders.” The CAS conceptualized ERM as proceeding across the two dimensions of risk type and risk management processes. The risk types and examples include:

Hazard risk

Liability torts, Property damage, Natural catastrophe

Financial risk

Pricing risk, Asset risk, Currency risk, Liquidity risk

Operational risk

Customer satisfaction, Product failure, Integrity, Reputational risk; Internal Poaching; Knowledge drain

Strategic risks

Competition, Social trend, Capital availability

The risk management process involves:

• Establishing Context: This includes an understanding of the current conditions in which the organization operates on an internal, external and risk management context.
• Identifying Risks: This includes the documentation of the material threats to the organization’s achievement of its objectives and the representation of areas that the organization may exploit for competitive advantage.
• Analyzing/Quantifying Risks: This includes the calibration and, if possible, creation of probability distributions of outcomes for each material risk.
• Integrating Risks: This includes the aggregation of all risk distributions, reflecting correlations and portfolio effects, and the formulation of the results in terms of impact on the organization’s key performance metrics.
• Assessing/Prioritizing Risks: This includes the determination of the contribution of each risk to the aggregate risk profile, and appropriate prioritization.
• Treating/Exploiting Risks: This includes the development of strategies for controlling and exploiting the various risks.
• Monitoring and Reviewing: This includes the continual measurement and monitoring of the risk environment and the performance of the risk management strategies.

The COSO ERM Framework has eight Components and four objectives categories. It is an expansion of the COSO Internal Control-Integrated Framework published in 1992 and amended in 1994. The eight components – additional components highlighted – are:

• Authority and pledge to the ERM
• RISK Management policy
• Mixer of ERM in the institution
• Risk Assessment
• Risk Response
• communication and reporting
• Information and Communication
• Monitoring

The four objectives categories, additional components highlighted are:

• Strategy: high-level goals, aligned with and supporting the organization’s mission
• Operations: effective and efficient use of resources
• Financial Reporting: Reliability of operational and financial reporting
• Compliance: Compliance with applicable laws and regulations

Differences and Solutions

Enterprise risk management is an extension of traditional risk management, and differs in the following ways.

• Strategic application. An ERM approach is integrated into an organizations business decision. Because the effort is enterprise-wide, it supersedes any departmental or functional autonomy to encourage continuous review and support of the organizations most value-based objectives.
• Risks considered. ERM involves managing all of the risks affecting an organization’s ability to meet its goals, regardless of the types of risks being considered. This carefully reviewed and benchmarked approach allows organizations the ability to stay focused on key areas of prosperity and survival.
• Performance metrics. ERM emphasizes results-based performance measurement throughout the organization. Results indicate whether a risk management technique helped to achieve a business goal, such as return on investment or return on assets. All forms of risk management, including ERM, are intended to help minimize the adverse effects of missed opportunities and losses.The specific benefits of ERM include maximizing the possible opportunities for growth, minimizing the expected organizational losses and therefore increasing the expected income and asset value, and reducing the residual uncertainty in all areas of the enterprise.

The returns potential of an investment option is of prime importance for every investor. But, while every investor would want to generate the highest possible returns, the quantum of risks involved is often overlooked.

The inherent nature of financial markets, irrespective of the type of investment you select, is such that the returns potential of the investment is directly linked to its risk. This phenomenon is known as risk-return trade-off.

The risk-return tradeoff states that the potential return rises with an increase in risk. Using this principle, individuals associate low levels of uncertainty with low potential returns, and high levels of uncertainty or risk with high potential returns. According to the risk-return tradeoff, invested money can render higher profits only if the investor will accept a higher possibility of losses.

Risk-Return Trade-Off Calculation

Generally, the risk and return trade-off are calculated with the help of a few metrics. For instance, in the case of mutual funds, investors determine the trade-off with the help of these metrics-

Alpha

Alpha measures the risk-adjusted returns of a mutual fund scheme against its underlying benchmark. For instance, if a particular mutual fund follows Nifty 50, the risk-adjusted returns of the fund above or below the performance of the benchmark are considered alpha.

For instance, a negative alpha of 1 means that the mutual fund underperformed in comparison to its benchmark by 1%. A positive alpha indicates that the fund outperformed its benchmark. Higher the alpha is, the higher is the returns potential of the mutual fund.

Beta

Beta measures the volatility of the fund in line with its underlying benchmark. Higher or positive beta means that the fund you have selected is more volatile as compared to its benchmark. Funds have lower or negative beta if their volatility is lower than the benchmark.

Funds with lower betas are highly recommended to new investors as they are less volatile. But less volatility often leads to lower returns as compared to a fund with higher beta. But higher beta does not guarantee higher returns.

Sharpe Ratio

Sharpe Ratio is used for analysing the risk-adjusted returns potential of a mutual fund scheme. In other words, it measures the potential returns of a scheme against each unit of risk the scheme has undertaken.

So, Sharpe Ratio of 1 means that the returns potential of a fund is higher than what is expected for an investment at a particular risk level. If the ratio is below 1, it signifies that the returns potential of the fund is lower than the quantum of risk carried by the fund.

Standard Deviation

Standard deviation measures the individual returns of an investment over time against its average return for the same period. So, a higher standard deviation of a mutual fund scheme means that the fund is volatile and carries a higher level of risk as compared to a fund with a lower standard deviation.

The standard deviation of a fund is compared against the standard deviation of funds from the same category to understand how volatile and risky a particular fund is.

The risk-return tradeoff is the trading principle that links high risk with high reward. The appropriate risk-return tradeoff depends on a variety of factors including an investor’s risk tolerance, the investor’s years to retirement and the potential to replace lost funds. Time also plays an essential role in determining a portfolio with the appropriate levels of risk and reward. For example, if an investor has the ability to invest in equities over the long term, that provides the investor with the potential to recover from the risks of bear markets and participate in bull markets, while if an investor can only invest in a short time frame, the same equities have a higher risk proposition.

Investors use the risk-return tradeoff as one of the essential components of each investment decision, as well as to assess their portfolios as a whole. At the portfolio level, the risk-return tradeoff can include assessments of the concentration or the diversity of holdings and whether the mix presents too much risk or a lower-than-desired potential for returns.

Measuring Singular Risk in Context

When an investor considers high-risk-high-return investments, the investor can apply the risk-return tradeoff to the vehicle on a singular basis as well as within the context of the portfolio as a whole. Examples of high-risk-high return investments include options, penny stocks and leveraged exchange-traded funds (ETFs). Generally speaking, a diversified portfolio reduces the risks presented by individual investment positions. For example, a penny stock position may have a high risk on a singular basis, but if it is the only position of its kind in a larger portfolio, the risk incurred by holding the stock is minimal.

Risk-Return Tradeoff at the Portfolio Level

That said, the risk-return tradeoff also exists at the portfolio level. For example, a portfolio composed of all equities presents both higher risk and higher potential returns. Within an all-equity portfolio, risk and reward can be increased by concentrating investments in specific sectors or by taking on single positions that represent a large percentage of holdings. For investors, assessing the cumulative risk-return tradeoff of all positions can provide insight on whether a portfolio assumes enough risk to achieve long-term return objectives or if the risk levels are too high with the existing mix of holdings.

Risk-Return Trade-Off in Mutual Funds

Even if you want to invest in mutual funds, you will see that the returns vary considerably between small-cap funds, mid-cap funds, large-cap funds, hybrid funds, debt funds, and others. Just like the returns, the quantum of risk varies too.

Small-cap equity funds have the highest level of risk, while debt funds are known to be relatively safer. But, the higher level of risk in small-cap funds can also deliver higher returns as compared to low-risk debt funds.

However, it is worth noting that a higher level of risk in no way guarantees higher returns. While high-risk investment options do have higher returns potential, this potential should never be confused with any guarantee. High-risk investments could very well deliver significant losses too.

A tool commonly used in risk management and project management. A risk register, also called a register log is created on the early stages of a project. It is an important document in your risk management plan; it enables you to identify potential risks in a project or an organization and at the same time, it helps you record and track issues and address problems as they arise. Although it is sometimes created just to fulfill regulatory requirements, it is a necessary tool to keep on top of potential issues that can deter you from your intended outcomes.

A risk register includes all relevant information about every risk that has been identified, from the nature of that risk to the level of risk to who owns it and down to what mitigation measures that have been put in place to respond to it. Generally, a risk register is shared between project stakeholders. It allows all of those involved in the project to be kept aware of issues and as well as providing a means of tracking the response to those issues. It can also be used to flag new project issues and also to give suggestions on what course of action is suitable to solve them.

As you may know, corporate and organizational projects may face risk at a certain point in time, a risk register provides better way and means to respond or address certain issues should they arise. Overall, a risk register is a useful tool that can help in the whole decision-making process and enables managers and project stakeholders to address issues in the most appropriate and effective way. Since a risk register contains all information about identified project risks, analysis of the severity of such risks and evaluations of the possible effective solutions to apply, people involved in the project can have a guarantee that issues can be resolved as quickly as possible.

It is imminent to have some sort of risks arise during the implementation of a project, however, these risks need not be a threat to the success of the project. Risks are simply issues that can arise during a project, if properly determined in advance, solution can also be determined. Therefore, risks can be resolved more efficiently and effectively with the use of the proper tools such as a risk management plan and a risk register.

There are five main indicators of investment risk that apply to the analysis of stocks, bonds, and mutual fund portfolios. They are alpha, beta, r-squared, standard deviation and the Sharpe ratio. These statistical measures are historical predictors of investment risk/volatility and they are all major components of modern portfolio theory (MPT).

MPT is a standard financial and academic methodology used to assess the performance of equity, fixed-income, and mutual fund investments by comparing them to market benchmarks.

Alpha

Alpha is a measure of an investment’s performance on a risk-adjusted basis. It takes the volatility (price risk) of a security or fund portfolio and compares its risk-adjusted performance to a benchmark index. The excess return of the investment relative to the return of the benchmark index is its alpha.

Simply stated, alpha is often considered to represent the value that a portfolio manager adds or subtracts from a fund portfolio’s return. An alpha of 1.0 means the fund has outperformed its benchmark index by 1%. Correspondingly, an alpha of -1.0 would indicate an underperformance of 1%. For investors, the higher the alpha the better.

Beta

Beta, also known as the beta coefficient, is a measure of the volatility, or systematic risk, of a security or a portfolio, compared to the market as a whole. Beta is calculated using regression analysis and it represents the tendency of an investment’s return to respond to movements in the market. By definition, the market has a beta of 1.0. Individual security and portfolio values are measured according to how they deviate from the market.

A beta of 1.0 indicates that the investment’s price will move in lock-step with the market. A beta of less than 1.0 indicates that the investment will be less volatile than the market. Correspondingly, a beta of more than 1.0 indicates that the investment’s price will be more volatile than the market. For example, if a fund portfolio’s beta is 1.2, it is theoretically 20% more volatile than the market.

Conservative investors who wish to preserve capital should focus on securities and fund portfolios with low betas while investors willing to take on more risk in search of higher returns should look for high beta investments.

R-squared

R-squared is a statistical measure that represents the percentage of a fund portfolio or a security’s movements that can be explained by movements in a benchmark index. For fixed-income securities and bond funds, the benchmark is the U.S. Treasury Bill. The S&P 500 Index is the benchmark for equities and equity funds.

R-squared values range from 0 to 100. According to Morningstar, a mutual fund with an R-squared value between 85 and 100 has a performance record that is closely correlated to the index. A fund rated 70 or less typically does not perform like the index.

Mutual fund investors should avoid actively managed funds with high R-squared ratios, which are generally criticized by analysts as being “closet” index funds. In such cases, it makes little sense to pay higher fees for professional management when you can get the same or better results from an index fund.

Standard Deviation

Standard deviation measures the dispersion of data from its mean. Basically, the more spread out the data, the greater the difference is from the norm. In finance, standard deviation is applied to the annual rate of return of an investment to measure its volatility (risk). A volatile stock would have a high standard deviation. With mutual funds, the standard deviation tells us how much the return on a fund is deviating from the expected returns based on its historical performance.

Sharpe Ratio

Developed by Nobel laureate economist William Sharpe, the Sharpe ratio measures risk-adjusted performance. It is calculated by subtracting the risk-free rate of return (U.S. Treasury Bond) from the rate of return for an investment and dividing the result by the investment’s standard deviation of its return.

The Sharpe ratio tells investors whether an investment’s returns are due to wise investment decisions or the result of excess risk. This measurement is useful because while one portfolio or security may generate higher returns than its peers, it is only a good investment if those higher returns do not come with too much additional risk. The greater an investment’s Sharpe ratio, the better its risk-adjusted performance.

Quantitative Risk Assessment (QRA) is finding, assessing and analyzing the risks. With this useful technique you are able to predict precisely in a quantifiable way how the risk will affect your work’s progress. The results generated from this method are made after keeping a variety of assumptions and constraints in mind thus ensuring the validity of the results made. It helps to make cost effective decisions and manages the risks for the project. This helps identify preventive measures thereby reducing the likelihood of affecting the company and its team members.

Quantitative risk assessment (QRA) software and methodologies give quantitative estimates of risks, given the parameters defining them. They are used in the financial sector, the chemical process industry, and other areas.

In financial terms, quantitative risk assessments include a calculation of the single loss expectancy of monetary value of an asset.

In the chemical process and petrochemical industries a QRA is primarily concerned with determining the potential loss of life (PLL) caused by undesired events. Specialist software can be used to model the effects of such an event, and to help calculate the potential loss of life. Some organisations use the risk outputs to assess the implied cost to avert a fatality (ICAF) which can be used to set quantified criteria for what is an unacceptable risk and what is tolerable.

For the explosives industry, QRA can be used for many explosive risk applications. It is especially useful for site risk analysis when reliance on quantity distance (QD) tables is not feasible.

Quantitative Risk Assessment Done

The risks are identified and recorded into a list. From this list, risks need to be prioritized and then fed into a Risk Register. These risks are then ranked according to their level of severity and impact by using probability distributions to calculate the risk’s impact and probability. It also utilizes constraints like schedule, cost estimates and other resources.

Limitations

Some of the QRA software models described above must be used in isolation: for example the results from a consequence model cannot be used directly in a risk model. Other QRA software programs link different calculation modules together automatically to facilitate the process. Some of the software is proprietary and can only be used within certain organisations.

Due to the large amount of data processing required by QRA calculations, the usual approach has been to use two-dimensional ellipses to represent hazard zones such as the area around an explosion which poses a 10% chance of fatality. Similarly, a pragmatic approach is used in the simplification of dispersion results. Typically a flat terrain, unobstructed world is used to determine the behaviour of a dispersing cloud and/or a vaporizing pool. This presents problems when the effects of non-flat terrain or the complex geometry of process plants would no doubt affect the behaviour of a dispersing cloud. Though they have limitations, the 2D hazard zone and simplified approach to 3D dispersion modelling allow the handling of large volumes of risk results with known assumptions to assist in decision-making. The trade-off shifts as computer processing power increases.

The modeling of the consequences of hazardous events in a true 3D manner may require a different approach, for example using a computational fluid dynamics method to study cloud dispersion over hilly terrain. The creation of CFD models requires significantly more investment of time on the part of the modeling analyst (because of the increased complexity of the modeling), which may not be justified in all cases.

One major limitation of QRA in the safety field is that it is focussed primarily on the loss of containment of hazardous fluids and what happens when they are released. This renders QRA somewhat unworkable in hazardous industries that do not focus on fluid containment yet are still subject to catastrophic events (e.g. aviation, pharmaceuticals, mining, water treatment, etc.) This has led to the development of a risk process that draws on the experience of organisations and their employees to produce risk assessments that produce potential loss of life (PLL) outputs without fault and event tree modelling. This process is probably most commonly known by the name SQRA which was the first methodology to enter the marketplace in the late 1990s but is perhaps more accurately described by the term Experience-based Quantification (EBQ). Today there is a choice of software with which to undertake this methodology and it has been used extensively in the mining industry on a global basis.

In an effort to be fairer and to avoid adding to already high imprisonment rates in the US, courts across America have started using quantitative risk assessment software when trying to make decisions about releasing people on bail and sentencing, which are based on their history and other attributes. It analyzed recidivism risk scores calculated by one of the most commonly used tools, the Northpointe COMPAS system, and looked at outcomes over two years, and found that only 61% of those deemed high risk actually committed additional crimes during that period and that African-American defendants were far more likely to be given high scores that white defendants. These results are part of larger questions being raised in the field of machine ethics with regard to the risks of perpetuating patterns of discrimination via the use of big data and machine learning across many fields.

Advantages of Quantitative Risk Assessment

Below you will find a comprehensive list of benefits that you get with QRA.

It helps identifying potential:

• Hazards that you may face in every phase of your project’s creation
• Economic losses
• Accidental scenarios and their consequences
• Damage to the basic functionality of the system
• Effects of uncertainties and assumptions
• Control strategies
• Measures that need to be adopted to reduce risk levels
• So that it can reduce their negative impacts and thus increase outcome.
• Estimates of the likelihood of meeting targets.
• Contingency which needs to be communicated to achieve the desired level of comfort.