UNIT II

Risk Avoidance and ERM

RISK HEDGING INSTRUMENTS AND MECHANISM
DERIVATIVES
Derivative is a contract or a product whose value is derived from value of some other asset
know as "underlying". When the price of the underlying changes, the value of the derivative
also changes. Derivative are based on wide range of underlying assets example gold, silver,
equity share, cotton etc.
According to Economic Times:

"A derivative is a contract between two parties which derives its value/price from an underlying
asset. The most common types of derivatives are futures, options, forwards and swaps".

FEATURES OF DERIVATES
1. Underlyings: the rates or prices that relate to the asset or liability underlying the derivative
instrument e.g: A derivate can be of stock, index, currency or commodity which is called the
underline. And the price of the derivate is based on the price of the underline.

2. Notional amount - the number of units or quantity that are specified in the derivative
instrument eg: Notional Amount here means a small amount of invested money can control a
large position in the markets ie by paying a small amount to buy a derivative contract the
investor gets the opportunity get a leveraged position.
3. Minimal initial investment - a derivative requires little or no initial investment because it is
an investment in a change in value rather than an investment in the actual asset or liability

4. No required delivery- generally the parties to the contract, the counterparties, are not required
to actually deliver an asset that is associated with the underlyin.

USES OF DERIVATIVES
1. Price Discovery
Futures market prices depend on a continuous flow of information from around the world and
require a high degree of transparency. A broad range of factors (climatic conditions, political
situations, debt default, refugee displacement, land reclamation and environmental health, for
example) impact supply and demand of assets (commodities in particular) - and thus the current
and future prices of the underlying asset on which the derivative contract is based. This kind
of information and the way people absorb it constantly changes the price of a commodity. This
process is known as price discovery.
2. Risk Management
This could be the most important purpose of the derivatives market. Risk management is the
process of identifying the desired level of risk, identifying the actual level of risk and altering
the latter to equal the former. This process can fall into the categories of hedging and
speculation.

3. They Improve Market Efficiency for the Underlying Asset

For example, investors who want exposure to the S&P 500 can buy an S&P 500 stock index
fund or replicate the fund by buying S&P 500 futures and investing in risk-free bonds. Either
of these methods will give them exposure to the index without the expense of purchasing all
the underlying assets in the S&P 500.

Derivatives Also Help Reduce Market Transaction Costs

Because derivatives are a form of insurance or risk management, the cost of trading in them
has to be low or investors will not find it economically sound to purchase such "insurance" for
their positions,

Speculation
This is not the only use, and probably not the most important use, of financial derivatives.
Financial derivatives are considered to be risky. If not used properly, these can leads to financial
destruction in an organisation like what happened in Barings Plc. However, these instruments
act as a powerful instrument for knowledgeable traders to expose themselves to calculated and
well understood risks in search of a reward, that is, profit.

Price stabilization function

Derivative market helps to keep a stabilising influence on spot prices by reducing the short-
term fluctuations. In other words, derivative reduces both peak and depths and leads to price
stabilisation effect in the cash market for underlying asset.

 Diversifying funding sources

 Hedging the cost
 Managing asset portfolio
 Managing foreign exchange
 Managing commodity prices
 Institutional investors
MARKET PARTICIPANTS
1. Hedgers
They face risk associated with the prices of underlying assets and use derivatives to o reduce
their risk. Corporations, investing institutions and banks all use derivative products to hedge or
reduce their exposures to market variables such as interest rates, share values, bond prices,
currency exchange rates and commodity prices

2. Speculators
They try to predict the future movements in prices of underlying assets and based on the view,
take positions in derivative contracts. Derivatives are preferred over underlying asset for
trading purpose, as they offer leverage are less expensive (cost of transaction is A generally
lower than that of the underlying) and are faster to execute in size (high volumes market).
In the Indian markets, there are two types of speculators - day traders and the position traders.

 A day trader tries to take advantage of intra-day fluctuations in prices. All their trades
are settled by undertaking an opposite trade by the end of the day. They do not have any
overnight exposure to the markets.
 On the other hand, position traders greatly rely on news, tips and technical analysis -
the science of predicting trends and prices, and take a longer view, say a few weeks or
a month in order to realize better profits. They take and carry position for overnight or
a long term.

3. Margin traders - Borrowing money from the broker to purchase stock

Many speculators trade using of the payment mechanism unique to the derivative markets. This
is called margin trading. When you trade in derivative products, you are not required to pay the
total value of your position up front.. Instead, you are only required to deposit only a fraction
of the total sum called margin. This is why margin trading results in a high leverage factor in
derivative trades. With a small deposit, you are able to maintain a large outstanding position.
The leverage factor is fixed; there is a limit to how much you can borrow.

4. Arbitrageurs
Arbitrageurs are in business to take advantage of a discrepancy between prices in two different
markets. They help in bringing price uniformity and discovery. Arbitrage is a deal that produces
profit by exploiting a price difference in a product in two different dens markets. Arbitrage
originates when a trader purchases an asset cheaply in one location and simultaneously arranges
to sell it at a higher price in another location.
Types of derivatives

 Forward contracts
 Futures
 Swaps
 Options

FORWARDS
Forward contract is an agreement made directly between two parties to buy or sell an asset on
a specific date in the future, at the terms decided today.

Features of forward contract

1. It is a contract between two parties (bilateral contract) i.e. there is no involvement of any
stock exchange and it's a contract between two individuals

2. All terms of contracts like price, quantity & quality of underlying, delivery terms like place,
settlement procedure etc are fixed on the day of entering into the contract
3. Alterations in the terms of the contract is possible if both parties agree to it.

4. Can be Taylor made to suite specific requirements

5. All parties are exposed to counterparty default risk - This is the risk that the other party may
not make the required delivery or payment.

6. They tend to be held to maturity and have little or no market liquidity.

7. Underlying assets can be a stocks, bonds, foreign currencies, commodities or some
combination thereof. The underlying asset could even be interest rates.

Limitations of Forwards

1. Liquidity Risk
Liquidity is nothing but the ability of the market participants to buy or sell the desired quantity
of an underlying asset. As forwards are tailor made contracts i.e. the terms of the contract are
according to the specific requirements of the parties, other market participants may not be
interested in these contracts. Forwards are not listed or traded on exchanges, which makes it
difficult for other market participants to easily access these contracts or contracting parties. The
tailor made contracts and their non- availability on exchanges creates illiquidity in the
contracts. Therefore, it is very difficult for parties to exit from the forward contract before the
contract's maturity.

2. Counter-party risk
Counter-party risk is the risk of an economic loss from the failure of counter-party to fulfil its
contractual obligation. For example, A and B enter into a bilateral agreement, where A will
purchase 100 kg of rice at 20 per kg from B after 6 months. Here, A is counter-party to B and
vice versa. After 6 months, if price of rice is ? 30 in the market then B may forego his obligation
to deliver 100 kg of rice at * 20 to A. Similarly, if dal price of rice falls to 15 then A may
purchase from the market at a lower price, instead of honouring the contract. Thus, a party to
the contract may default on his obligation if there is incentive to default. This risk is also called
default risk or credit risk. In addition to the illiquidity and counter-party risks, there are several
issues like lack of transparency, settlement complications as it is to be done directly between
the contracting parties. Simple solution to all these issues lies in bringing these contracts to the
centralised trading platform. This is what futures contracts do.

FUTURES
Futures markets were innovated to overcome the limitations of forwards. A futures contract is
an agreement made through an organised exchange to buy or sell a fixed amount of a
commodity or a financial asset on a future date at an agreed price. Simply. futures are
standardised forward contracts that are traded on an exchange. The clearinghouse associated
with the exchange guarantees settlement of these trades. A trader, who buys futures contract,
takes a long position and the one, who sells futures, takes a short position. The words buy and
sell are figurative only because no money or underlying asset changes hand, between buyer
and seller, when the deal is signed.

Features of futures contract

In futures market, exchange decides all the contract terms of the contract other than price.
Accordingly, futures contracts have following features:

 Standardized Contract: Contract between two parties through Exchange. Terms and
conditions are standardized
 Centralised trading platform i.e. exchange Trading takes place on a formal exchange
wherein the exchange provides a place to engage in these transactions and sets a
mechanism for the parties to trade these contracts. guaranteeing
 There is no default risk because the exchange acts as a counterparty, delivery and
payment by use of a clearing house.
 The clearing house protects itself from default by requiring its counterparties to settle
gains and losses or mark to market their positions on a daily basis.
 An investor can offset his or her future position by engaging in an opposite transaction
before the stated maturity of the contract.

OPTIONS
As seen in earlier section, forward/futures contract is a commitment to buy/sell the underlying
and has a linear pay off, which indicates unlimited losses and profits. Some market participants
desired to ride upside and restrict the losses. Accordingly, options emerged as a financial
instrument, which restricted the losses with a provision of unlimited profits on buy or sell of
underlying asset.
An Option is a contract that gives the right, but not an obligation, to buy or sell the underlying
asset on or before a stated date/day, at a stated price, for a price. The party taking a long position
i.e. buying the option is called buyer/ holder of the option and the party taking a short position
i.e. selling the option is called the seller/ writer of the option.

The option buyer has the right but no obligation with regards to buying or selling the underlying
asset, while the option writer has the obligation in the contract. Therefore, option buyer/ holder
will exercise his option only when the situation is favourable to him, but, when he decides to
exercise, option writer would be legally bound to honour the contract.

Options may be categorised into two main types:

 Call option
 Put option

Option, which gives buyer a right to buy the underlying asset, is called Call option and the
option which gives buyer a right to sell the underlying asset, is called Put option.

FEATURES OF OPTIONS CONTRACT

1. Highly flexible
On one hand, option contract are highly standardized and so they can be traded only in
organized exchanges. Such option instruments cannot be made flexible according to the
requirements of the writer as well as the user. On the other hand, there are also privately
arranged options which can be traded 'over the counter'. These instruments can be made
according to the requirements of the writer and user. Thus, it combines the features of 'futures
as well as 'forward' contracts.

2. Down Payment
The option holder must pay a certain amount called 'premium for holding the right of exercising
the option. This is considered to be the consideration for the contract. If the option holder does
not exercise his option, he has to forego this premium. Otherwise, this premium will be
deducted from the total payoff in calculating the net payoff due to the option holder.

3. Settlement
No money or commodity or share is exchanged when the contract is written. Generally this
option contract terminates either at the time of exercising the option by the option holder or
maturity whichever is earlier. So, settlement is made only when the option holder exercises his
option. Suppose the option is not exercised till maturity, then the agreement automatically
lapses and no settlement is required.
4. Non-Linearity
Unlike futures and forward, an option contract does not posses the property of linearity. It
means that the option holder's profit, when the value of the underlying asset moves in one
direction is not equal to his loss when its value moves in the opposite direction by the same
amount. In short, profits and losses are not symmetrical under an option contract. This can be
illustrated by means of an illustration:

5. No Obligation to Buy or Sell

In all option contracts, the option holder has a right to buy or sell an underlying asset. He can
exercise this right at any time during the currency of the contract. But, in no case, he is under
an obligation to buy or sell. If he does not buy or sell, the contract will be simply lapsed.

SWAPS
A swap is an agreement between two parties to exchange sequences of cash flows for a set
period of time. Usually, at the time the contract is initiated, at least one of these series of cash
flows is determined by a random or uncertain variable, such as an interest rate, foreign
exchange rate, equity price or commodity price. Conceptually, one may view a swap as either
a portfolio of forward contracts, or as a long position in one bond coupled with a short position
in another bond.

Exiting a Swap Agreement:

Sometimes one of the swap parties needs to exit the swap prior to the agreed-upon termination
date. This is similar to an investor selling an exchange-traded futures or option contract before
expiration. There are four basic ways to do this:

1. Buy Out the Counter-party

Just like an option or futures contract, a swap has a calculable market value, so one party may
terminate the contract by paying the other this market value. However, this is not an automatic
feature, so either it must be specified in the swaps contract in advance, or the party who wants
out must secure the counter party's consent.

2. Enter an Offsetting Swap

For example, Company A from the interest rate swap example above could enter into a second
swap, this time receiving a fixed rate and paying a floating rate.

3. Sell the Swap to Someone Else

Because swaps have calculable value, one party may sell the contract to a third party. As with
Strategy 1, this requires the permission of the counter-party.
4. Use a Swaption
A swaption is an option on a swap. Purchasing a swaption would allow a party to set up, but
not enter into, a potentially offsetting swap at the time they execute the original swap. This
would reduce some of the market risks associated with Strategy 2.

ARBITRAGE THEORY AND TECHNIQUES

Arbitrage is the simultaneous buying and selling of securities, currency, or commodities in
different markets or in derivative forms in order to take advantage of differing prices for the
same asset.

1. Risk Arbitrage
The theory
When one company seeks to acquire another company there is a discrepancy between the deal
price offered by the acquirer and the market price of the target company

The strategy
In the event of a stock-for-stock deal, the arbitrageur will buy shares of the target company and
sell shares of the acquiring company a ratio to equal that of the proposed transaction. In the
event of a cash-for-stock deal, the arbitrageur will buy shares of the target company and borrow
money to finance the transaction.
The risk
The acquirer walks away from the deal. This can occur because of "material adverse changes”.

2. Index Arbitrage
The theory

One can buy all the stocks in an index (like the S&P 500) relative to the value that is implied
in the market price of the futures contracts underlying that index (see Five Things Every
Investor Should Know About Index Futures").

The strategy
The arbitrageur will buy all of the stocks underlying the index and sell the futures for the index.
In the process, the investor will borrow money to buy the stocks, pay interest on the loan and
earn dividends on the stocks. As such, the perceived profit is equal to:

Cost of stocks plus dividends on stocks minus interest costs minus futures value
The risk

If interest rates increase or dividends decline from their anticipated rates, then the perceived
profit will erode or potentially turn to a loss.
3. Carry Trade
The theory
Put simply, you borrow money at a lower interest rate and reinvest it at a higher interest rate,
earning the differential in interest rates along the way.

The strategy
This can be done in the foreign currency (forex) markets or may also be performed in the bond
markets.

The risk
The USD/JPY exchange rate changes such that the investor has to purchase more expensive
JPY when the transaction unwinds. To combat this, one might be inclined to buy a forward
forex contract to eliminate that exchange rate risk. However, doing so might eliminate the entire
perceived profit.

4. International Arbitrage
The theory

When foreign-based companies issue stock in their country, these are referred to as ordinary
shares (ORDS). In order to allow investors in other markets, such as in the United States, to
have ownership in one of these companies, the company will issue American Depository
Receipts (ADRs) or Global Depository Receipts (GDRs).

The strategy
The arbitrageur will buy the ORDS shares and short-sell the ADRs or vice versa. depending on
their relative valuations. In order to determine which is rich and which is cheap, you need to
recall the pricing formula for ADRS:

The risk
Once again, there is inherent risk in forex rates. Since you have to execute different legs of the
strategy in two geographically different markets, which might not be open simultaneously, then
you have face market risks that result from the time differential. Furthermore, since there are
operational costs for converting ADRs to ORDs, sometimes ADRs will trade at a normal
discount to the ORDs and the perceived profit is actually a permanent discount.

5. Convertible Arbitrage
The theory
From time to time, corporations will issue debt that is convertible into shares of the issuing
company. By doing so, the company will pay an interest rate that is lower than that which
would be paid on non-convertible or "straight" debt. Convertible debt is a hybrid security that
is comprised of a straight debt instrument plus an embedded call option.

Convertible arbitrage seeks to exploit the pricing anomalies that are associated with the
embedded option in the convertible bond.
The strategy
The usual convertible arbitrage is comprised of the investor purchasing the convertible security
and then selling a series of hedges.

The risk
The are many moving parts to the convertible arbitrage that not only create opportunities, but
can also create risks. Losses can be generated by unexpected changes in the underlying stock
price, interest rates or credit rating of the issuer.

RISK AND RETURN TRADE OFF

In the investing world, the dictionary definition of risk is the chance that an investment's actual
return will be different than expected. Technically, this is measured in statistics by standard
deviation. Risk means you have the possibility of losing some, or even all, of your original
investment.
Low levels of uncertainty (low risk) are associated with low potential returns. High levels of
uncertainty (high risk) are associated with high potential returns. The risk/return tradeoff is the
balance between the desire for the lowest possible risk and the highest possible return. This is
demonstrated graphically in the chart below. A higher standard deviation means a higher risk
and higher possible return.

Risk tolerance differs from person to person. Your decision will depend on your goals, income
and personal situation, among other factors.
1. The risk-return trade-off is the principle that potential return rises with an increase in risk.
Low levels of uncertainty or risk are associated with low potential returns, whereas high levels
of uncertainty or risk are associated with high potential returns.

2. According to the risk-return trade-off, invested money can render higher profits only if the
investor is willing to accept the possibility of losses.
3. The appropriate risk-return tradeoff depends on a variety of factors including risk tolerance,
years to retirement and the potential to replace lost funds.
4. Time can also play an essential role in determining a portfolio with the appropriate levels of
risk and reward. For example, the ability to invest in equities over the long- term provides the
potential to recover from the risks of bear markets and participate in bull markets, while a short
time frame makes equities a higher risk proposition.

5. For investors, the risk-return tradeoff is one of the essential components of each investment
decision as well as in the assessment of portfolios as a whole. At the foundation of this
assessment, the consideration of the risk as well as the reward of an investment can determine
whether taking action makes sense or not.

6. At the portfolio level, the risk-return trade off can include assessments on the concentration
or the diversity of holdings and whether the mix presents too much risk or a lower than desired
potential for returns.

MARKOWITZ RISK RETURN

Modern Portfolio Theory
Markowitz has explained the importance of consideration of Risk and Return in the MPT
(MODERN PORTFOLIO THEORY) Modem portfolio theory (MPT) is a theory on how risk-
averse investors can construct portfolios to optimise or maximise expected return based on a
given level of market risk. emphasising that risk is an inherent part of higher reward. According
to the theory, it's possible to construct an "efficient frontier of optimal portfolios offering the
maximum possible expected return for a given level of risk. This theory was pioneered by
Harry Markowitz in his paper "Portfolio Selection," published in 1952 by the Journal of
Finance.

Insight
1. A major insight provided by MPT is that an investment's risk and return characteristics
should not be viewed alone, but should be evaluated by how the investment affects the overall
portfolio's risk and return.
2. MPT shows that an investor can construct a portfolio of multiple assets that will maximise
returns for a given level of risk. Likewise, given a desired level of expected return, an investor
can construct a portfolio with the lowest possible risk.

3. Based on statistical measures such as variance and correlation, an individual investment's

return is less important than how the investment behaves in the context of the entire portfolio.

Efficiency Frontier
Every possible combination of assets that exists can be plotted on a graph, with the portfolio's
risk on the X-axis and the expected return on the Y-axis. This plot reveals the most desirable
portfolios. For example, assume Portfolio A has an expected return of 8.5% and a standard
deviation of 8%, and that Portfolio B has an expected return of 8.5% and a standard deviation
of 9.5%. Portfolio A would be deemed more "efficient" because it has the same expected return
but a lower risk.
It is possible to draw an upward sloping hyperbola to connect all of the most efficient portfolios,
and this is known as the efficient frontier. Investing in any portfolio not on this curve is not
desirable.

Harry Markowitz was awarded a Nobel prize for developing MPT.

SYSTEM AUDIT SIGNIFICANCE IN RISK MANAGEMENT

Following reasons make the system audit and internal control systems important for an
organisation.

 A company's risk management and internal control systems have key roles in the
management of risks that are significant to the fulfilment of its business objectives. A
sound system of internal control contributes to safeguarding the shareholders'
investment and the company's assets.
 Enterprise risk management enables management to identify, assess, and manage risks
in the face of uncertainty, and is integral to value creation and preservation. Enterprise
risk management is most effective when these mechanisms are built into the entity's
infrastructure and are part of the essence of the enterprise. By building in enterprise risk
management, an entity can directly affect its ability to implement its strategy and
achieve its mission.
 Risk management and internal control systems are an integral part of enterprise risk
management. This enterprise risk management framework encompasses internal
control, forming a more robust conceptualisation and tool for management and regular
system audit.
 Internal control the effectiveness and efficiency of operations, helps ensure the
reliability of internal and external reporting and assists compliance with laws and
regulations.
 Effective financial controls, including the maintenance of proper accounting records,
are an important element of internal control. They help ensure that the company is not
unnecessarily exposed to avoidable financial risks and that financial information used
within the business and for publication is reliable. They also contribute to the
safeguarding of assets, including the prevention and detection of fraud.
 A company's objectives, its internal organisation and the environment in which it
operates are continually evolving and, as a result, the risks it faces are continually
changing. Sound risk management and internal control systems therefore depend on a
thorough and regular evaluation of the nature and extent of the risks to which the
company is exposed. Since profits are, in part, the reward for successful risk-taking in
business, the purposes of risk management and internal control systems are to help
manage and control risk appropriately rather than to eliminate it.
ENTERPRISE RISK MANAGEMENT
Enterprise Risk Management is a process, effected by an entity's Board of Directors,
management and other personnel, applied in strategy setting and across the enterprise, designed
to identify potential events that may affect the entity, and manage risks to be within its risk
appetite, to provide a reasonable assurance regarding the achievement of entity objectives.
COSO Enterprise Risk Management Integrated Framework, 2004.
ERM includes the following activities:

 Establishing an appropriate internal environment, including a risk management policy

and framework;
 Defining risk appetite;
 Identifying potential threats to the achievement of its objectives and assessing the risk
i.e., the impact and likelihood of the threat occurring:
 Undertaking control and other response activities; Communicating information on risks
in a consistent manner at all levels in the organisation;
 Centrally monitoring and coordinating the risk management processes and the
outcomes, and
 Providing an assurance on the effectiveness with which risks are managed.

BENEFITS OF ENTERPRISE RISK MANAGEMENT

ERM when implemented in a right manner can yield substantial benefits to an organisation.
Companies which are considered to be well governed get a premium both by rating agencies
and shareholders. Some primary benefits include:

 Better-informed decisions
 Greater management consensus
 Increased management accountability
 Smoother governance practices
 Ability to meet strategic goals
 Better communication to Board
 Reduced earnings volatility Increased profitability
 Use risk as a competitive tool
 Accurate risk-adjusted pricing

Implementing ERM
Based on the understanding mentioned herein, the ERM implementation activities could be
summarised as follows:

Board Level Activities

The Board level activities include:

 Provide ERM education at the Board level.

 Establish buy out at the Board level for risk appetite and risk strategy.
 Develop the ownership of risk management oversight by the Board.
 Review the risk report of the enterprise. Management Level Activities

ERM MATRIX

Step 1: Preparing the Internal Environment

The first step is to prepare the internal environment of an organisation for the ERM
implementation. This would involve the preparedness of the organisation from the Board to the
junior management level for the ERM. The organisation would also define its risk management
philosophy and risk appetite during this stage.

Key output of this stage are:

 Risk Management Philosophy

 Risk Management Survey and its outcomes
 Code of Conduct
 Project

Step 2: Objective Setting

Key output of this stage are:

 Linkage of mission-strategic objectives-derived objectives

 Defining strategies by using risk management techniques
 Defining overall risk appetite for various business activities
 Defining risk tolerances for sub activities in line with the overall risk appetite for the
business activities.

Step 3: Event Identification

The next step in an ERM implementation is the identification of the events which may affect
the entity positively or negatively in achieving its objectives. Such events can be classified as
risks and opportunities, depending on their impact. An organisation should also consider the
interdependencies of events on the organisation as whole. An event, individually, may not affect
an organisation, however together with other events, it might increase the impact. These events
are also termed as risks.
Key outputs of this stage are:

 Interviews, workshop for event identification

 Linkage of events to objectives
 Event inventory for further actions
Step 4: Risk Assessment
Once events/risks are identified, the next step is assessing the risks in terms of their impact on
the objectives and the likelihood of such an impact. This is done by assigning qualitative and
quantitative values to each risk event and its likelihood. All risk events need to be first evaluated
on an inherent basis (considering their impact assuming that there is no remediation or response
mechanism).

Step 5: Risk Response

The next step to risk assessment is developing a response to the risks identified in earlier stages.
Management needs to evaluate each risk based on its gross risk (identified earlier) and develop
or identify existing response mechanism to ensure that the net/residual risk (after considering
the response) is within the risk tolerance levels of the organisation. Management should also
perform a cost benefit evaluation of the risk response, since all responses may not be suitable
in a particular scenario and response needs to be customised to each organisation. Response to
the risk can be as follows:
1. Avoid
2. Reduce

3. Share
4. Accept

Key output at this stage are:

 Risk Response for risks identified

 Risk portfolio after considering the residual risk Step

6: Control Activities
Risk response is the starting point of risk mitigation; however risks can be mitigated only when
the response is implemented. Similarly, responses across the organisation at various levels
should also be implemented. Controls are activities which ensure that the risk response is
implemented for the identified risks. Thus, each of the risk response would have a control
activity to support the risk response. Control activities include activities like reviews,
approvals, authorisations, schedule of authority, policies, procedures, segregation of duty,
safeguarding of assets and key performance indicators.
DIFFERENCE BETWEEN RISK MANAGEMENT AND ENTERPRISE RISK
MANAGEMENT

SWOT ANALYSIS
SWOT is a strategic planning tool used to evaluate the strengths, weaknesses, opportunities,
and threats to a project. It involves specifying the objective of the project and identifying the
internal and external factors that are favourable and unfavourable to achieving that objective.
The strengths and weaknesses usually arise from within an organisation, and the opportunities
and threats from external sources. This method is used for assessment of possible risk in the
future. The presence of risk may mean a threat or opportunity (double side of risk) for the
project (procedure / object) being examined /analysed. The goal of assessment is to get an
overview on options how to lower probability of threat and increase probability of opportunity.
This method is used for assessment of possible risk in the future.

Danger and risk output is not expected in SWOT analysis. SWOT analysis is in most cases a
good source of suggestions. The method is based on comparison of the subject to competition
subjects or products. The principle lies in determination of strong and weak sides in comparison
to competing organisations (products, individuals), from possible chances and risks resulting
from environment and from strong and weak sides of the subject (enterprise/ product). This
means in analysis you determine strong and weak sides (in view of goal of analysis) and deduce
opportunities and risks resulting from environment as well as from position of "our" strong and
weak sides.

The SWOT analysis is an important part of the project planning process:

 Strengths: attributes of the organisation that help achieve the project objective.
 Weaknesses: attributes of the organisation that stop achievement of the project
objective.
 Opportunities: external conditions that help achieve the project objective.
 Threats: external conditions that could damage the project.
Advantages of SWOT

 Straightforward and only costs time to do.

 Produces new ideas to help take advantage of an organisation's strengths and defends
against threats.
 Awareness of political and environmental threats allows an organisation to have
response plans prepared.
Disadvantages of SWOT

 May persuade organisations to compile lists rather than think about what is essential to
achieving objectives.
 Presents lists uncritically and without clear prioritisation so, for example, weak
opportunities may appear to balance strong threats.
 Usually, a simple list and not critically presented.

RISK REGISTER
The risk register starts, of course, with a risk management plan. The project manager must seek
input from team members as well as stakeholders and possibly even end users. The risk register
or risk log becomes essential as it records identified risks, their severity, and the actions steps
to be taken.

Components of a Risk Register

There is no standard list of components that should be included in the risk register. The Project
Management Institute Body of Knowledge (PMBOK) and PRINCE2 among other
organisations make recommendations for risk register contents, but they are not set in stone.
Some of the most widely used components are as follows:

 Dates: As the register is a living document, it is important to record the date that risks
are identified or modified. Optional dates to include are the target and completion dates.
 Description of the Risk: A phrase that describes the risk.
 Risk Type (business, project, stage): Classification of the risk: Business risks relate to
delivery of achieved benefit;, project risks relate to the management of the project such
 as timeframes and resources, and stage risks are risks associated with a specific stage
of the plan.
 Likelihood of Occurrence: Provides an assessment on how likely it is that this risk will
occur. Examples are: L-Low (, M-Medium (31-70% ), H-High (>70%).
 Severity of Effect: Provides an assessment of the impact that the occurrence of this risk
would have on the project.
 Countermeasures: Actions to be taken to prevent, reduce, or transfer the risk. This may
include production of contingency plans.
 Owner: The individual responsible for ensuring that risks are appropriately engaged
with countermeasures undertaken.
 Status: Indicates whether this is a current risk or if risk can no longer arise and impact
the project. Example classifications are: C-current or E-ended.
 Other columns such as quantitative value can also be added if appropriate.