GE1204

Living with the Unexpected and Unknown in Modern

Society
F o r e s t e r Wo n g
y tf w o n g @ c i t y u . e d u . h k
Group Presentation
Research based presentation: On a high-profile
company, risk they face and their risk management
strategies

20 minutes long presentation

All members must present

Optional discussion about the advantages/limitations of

Ai Chatbot
Individual Report
Watch a Netflix movie and answer assigned questions

Due at the start of week 8

Max 2 page typed on A4 paper, font 12, 1.5 line spacing.

Final Exam
Open book

More multiple choices

What is risk?
• Risk refers to the potential for loss or
gain that accompanies any decision
or action

• It's a measure of the potential of an

expected outcome/ goal

• In everyday life and business, risk is

inherent in all decisions. Having a
framework to identify significant risk
is crucial for making informed decisions
and achieving desired outcomes
What is negative risk?

Normally take 40 to 50 mins

Risk 1: Road work > Traffic jam
Risk 2: You ran out of fuel

Risk 3: You have a flat tire

Risk 4: No parking
What is positive risk (aka
opportunities)?

Normally take 40 to 50 mins

Opportunity 1: Get there faster
Opportunity 2: Found a short cut
Opportunity 3: Found a free parking
Opportunity 4: Your date can’t wait
to see you, so he/she came and
picked you up
How significant is a particular
risk?
At its core, risk involves the possibility of something
happening that could have an impact on our goals,
objectives, or expectations.
1.Probability: The likelihood of a
particular event occurring. In our
daily lives, this could be anything
from such as the chance of rain to
getting run over by a truck.
2.Impact: This is about the
significance of the event's
consequences. Impact can vary
greatly depending on the event –
from minor inconveniences to
major disruptions.
How significant is a particular
risk?
Example:

Supposed you invested in a

particular stock, expecting to make
a 10% return per year. To the right
is the past two years performance
of this stock.

In Class Poll 1: Does this

investment pose a significant risk
to you?
Vote
at slido.com with #1937360
How significant is a particular
risk?
Example:

Looking at the historical return, the

probability that I will make exactly
10% return seems look. Because the
return fluctuate a lot.

But the impact on my life seems low,

since the $ involved is only $1,747.

For my overall financial wellbeing, this

risk does not seem very significant.
Vote
at slido.com with #1937360
Risk vs. Uncertainty
•In class poll 2: Are risk and uncertainty the same
thing?

Vote
at slido.com with #1937360
Risk vs. Uncertainty
•Risk: Involves situations where the probabilities of
outcomes are known or can be estimated. Risks are
quantifiable and often based on past data and statistical
analysis.
Risk vs. Uncertainty
•Risk: Involves situations where the probabilities of
outcomes are known or can be estimated. Risks are
quantifiable and often based on past data and statistical
analysis.

Heads
50%
Flip a
Balanced
coin
50%
Tails
Risk vs. Uncertainty
•Risk: Involves situations where the probabilities of
outcomes are known or can be estimated. Risks are
quantifiable and often based on past data and statistical
analysis.

Uncertainty: Arises in situations where it's not possible to

know all the outcomes or their probabilities. It represents a
lack of predictability and the inability to calculate risks
accurately. Uncertainty make a certain action even more risky
Heads
50%
Flip a
Balanced
coin
50%
Tails
Risk vs. Uncertainty
•Risk: Involves situations where the probabilities of
outcomes are known or can be estimated. Risks are
quantifiable and often based on past data and statistical
analysis.

Uncertainty: Arises in situations where it's not possible to

know all the outcomes or their probabilities. It represents a
lack of predictability and the inability to calculate risks
accurately. Uncertainty make a certain action even more risky
New AI
Heads ?% Robot this yr.
50%
Flip a Introduction
Balanced of New ?%
Unknow
coin Tech
50% ?%
Tails Nothing
Risk vs. Uncertainty
•The following are generally considered risk
because the outcome are known, and the
probabilities can also be estimated with some
accuracy
•Flipping a coin
•Gambling at a casino (Baccarat, Blackjack, Roulette,
and etc.)
•Sex of your child (around 51.8% male)
•Rolling a dice
•Side effects from a drug?
Risk vs. Uncertainty
•The following are generally considered
uncertainty because the outcomes are
unknown, and the probabilities of these
outcomes are also unclear
•Company launching a revolutionary new product in an untested
market
• Unknown market demand, technological feasibility, reception by customers
• If the company had prior data (e.g., from launching similar products or existing demand
for related items), they could estimate the probabilities of success or failure and turn
this into a risk

•Impact of a revolutionary technology

• For example, with the invention of Ai, a lot remains uncertain
• The timeline for widespread adoption, its specific implications for businesses
Risk vs. Uncertainty
•MCQ 1: Gambling is a/an :
• Risk Vote at slido.com with #1937360
• Uncertainty
•MCQ 2: After getting married, whether you get divorced
or not is:
• Risk
• Uncertainty
•MCQ 3: The happiness of your marriage is a/an :
• Risk
• Uncertainty
•MCQ 4: Who you meet at CityU is a/an :
• Risk
• Uncertainty
•MCQ 5: The taste of my mum’s cooking tonight is a/an:
• Risk
• Uncertainty
•MCQ 6: Guessing the right MCQ answer in the exam is
a/an:
• Risk
• Uncertainty
Categories of Risks
(Idiosyncratic risk)
There are largely speaking three categories of
risks
•Idiosyncratic risk (from a society point of view: least
significant)
•Systematic risk
•Systemic risk (from a society point of view: most
significant)
Idiosyncratic risk
•Idiosyncratic risk is a unique risk that is specific to
an individual situation or entity. In finance, this is
risk that is inherent to a specific asset or company
•Finance Example: Suppose you are thinking about
buying Coca Cola stock, the idiosyncratic risks are risk
that is unique to Coca Cola; not related to the overall
market (CEO got a divorce, fire at the Coke factory,
insect inside the drinks and etc.)
•Everyday Example: Imagine you own a coffee shop;
and your espresso machine breaks down
unexpectedly. This is an idiosyncratic risk, because it
is specific to your shop and doesn't affect other coffee
shops or businesses
Systematic risk
•Systematic risks are risks that affects the entire
market or a large segment of the market
•Unavoidable and non-diversifiable, impacting all
businesses and investments to some degree
•Example: Economic recession cause everyone to cut down on
spending. People buy less coke, drink less coffee, buy less cars, go
out less. The entire economy is affected.
•Other example include political instability, natural
disasters, and etc.
Categories of Risks
(Idiosyncratic vs. systematic
risk)
•In Class Poll 3: If I own 100 stocks in my portfolio, I
am exposed to?
a) Large amount of both idiosyncratic and systematic
risk
b) Mostly idiosyncratic risk
c) Mostly systematic risk
d) What’s risk?

Vote at slido.com with #1937360

Diversification and Risks
•Remember idiosyncratic risks are risks that is specific
to an individual company
•One can limit idiosyncratic risk by spread investments
across different assets
•For example, if you own Coke, Microsoft and Walmart.
Coke’s
factory may burn down, but Microsoft
may discover ChatGPT. Loses in Coke
offset by gains in Microsoft
Systemic Risk (NOT systematic
risk)
• Systemic risk refers to the collapse of an entire
system (as opposed to risk associated with any one
individual entity, group, or component), triggered by
one individual component/event

• It is caused by a domino
effect or chain reaction,
where the failure of one entity
leads to a chain of failures.

• Examples include major financial crises, such as the

global financial crisis of 2008, which was initiated by
the collapse of Lehman Brothers, leading to
widespread economic disruption.
Systemic Risk (NOT systematic
risk)
•https://www.youtube.com/watch?v=UzW195qWHYg
Takeaway of the video
•Systemic Risk can occur in our everyday life
•The video provided two examples of systemic risk
• Example 1: The bridge
• Systemic risk is that everyone on the bridge would step in the left and
right together, creating forces that is so great that it can cracked the
bridge
• Engineering thought this would never happen, because there are people
that did not know each other will step on and off the bridge and they
will be doing their own thing
• The event that triggered the failure, was that there was a large wind
come from the right, this caused some of the people on the bridge to
step to the left to try and stabilize themselves. Causing the bridge to
lean to the left. As a result, in order to stabilize themselves, everyone to
lean to the right together. Then everyone lean to the left…
Takeaway of the video
•Systemic Risk can occur in our everyday life
•The video provided two examples of systemic risk
• Example 2: The flash crash
• The systemic risk is the possibility that everyone in the market will sell
the same securities at the same thing, causing a complete market failure
(for a market to function, we need buyers and sellers)
• We do not expect this to happen, because we expect someone to be
buying and selling all the time. If a stock is worth $100, we expect
someone to buy it when it goes to $99.
• One Ai trading started selling, normally this would be offset by other Ai
that will buy. But this time, every Ai happened to sell together.
Systemic risk vs systematic
risk
• Systemic risk refers to risk that will collapse of an
entire system

• Systematic risk refers to risk that affect the whole

economy/system

• If the risk only create a disruption to the system, then

it is systematic (i.e. all stock go down by 5%), but if
the risk causes the whole system to breakdown, then
it is systemic (i.e., the stock market system breaks)
A recent example of Systemic
Risk:
The 2008 financial crisis
•The 2008 financial crisis was one of the most severe
economic downturns in modern history, and its effects
were felt around the world
•Approximately 8.8 million people lost their jobs, and
unemployment rate hit 10% in the US, and countries
like Spain unemployment reached 20%
•Approximately 10 million families in the US lost their
homes to foreclosure
A recent example of Systemic
Risk:
The 2008 financial crisis
•The crisis wasn’t just an accident—it was the result of
banks taking too much risk and regulators’ lack of
oversight.
•So, what happened?
• In the early 2000s, housing prices in the U.S. skyrocketed, and
everyone wanted to buy a house, even for people who couldn’t really
afford them
A recent example of Systemic
Risk:
The 2008 financial crisis
•The crisis wasn’t just an accident—it was the result of
banks taking too much risk and regulators’ lack of
oversight.
•So, what happened?
• In the early 2000s, housing prices in the U.S.
skyrocketed, and everyone wanted to buy a house,
even for people who couldn’t really afford them
• These people went to the banks to get a mortgage
(loan)
• Banks knew that these people could not afford them,
but managers at banks were compensated on the $
amount of loans they issue
• So, banks issued these loans and called them
subprime mortgages
• Because they banks know these are junk, they want to
sell the mortgages off to other investors (so it become
A recent example of Systemic
Risk:
The 2008 financial crisis
•BUT, no one would buy these subprime mortgages, so
the bankers packaged these mortgage into complex
financial products call mortgage-backed securities
(MBS)
•The banks then sold these to investors, claiming they
were “safe”
•The justification is that each MBS is made up of many
loans, the risk of them all defaulting together is
considered very low, hence rated SUPER SAFE (the
argument is that individual defaulting is idiosyncratic
and got diversified away)
A recent example of Systemic
Risk:
The 2008 financial crisis
• When people started defaulting on their loans (because they
couldn’t afford the payments), the housing bubble burst.
Home prices fell dramatically, and those mortgage-backed
securities lost their value. This caused huge losses for banks
and investors

• Almost all financial institutions froze up overnight (Lehman

Brothers went bankrupt), because banks stopped lending to
each other, collapsing the entire US banking system
• Since the US system was integrated with the rest of the
world, the crisis spread to other countries very quickly
A recent example of Systemic
Risk:
The 2008 financial crisis
•The systemic risk: Downturn in the housing market
would cause multiple large banks to collapse and
other banks to stop lending. This collapsed the entire
banking system.
•Expectation: We do not expect the whole housing
market to crash in the USA. Prior to 2000s, banks only
had exposure to their local region. So, we do not
expect all banks to take too much risk and fail at the
same time, normally, if New York housing market
crash, then banks in NY that took on too much risk
would fail, and other banks are fine.
•Reality: Pretty much every single large bank took on
too much risk. Every bank had very large expose to
the housing market. The expose was too large to
estimate. The same loan got sold multiple times.
Group Exercise: Debate
•Get into small groups of 4-6 members
•Groups on the left side of the classroom
• Argue how stronger risk management at banks
could have prevented the 2008 crisis, and propose
two specific measures to reduce excessive risk-
taking
•Groups on right side of the classroom
• Argue how stronger risk management by regulators
could have prevented the 2008 crisis, and propose
two specific measures to reduce excessive risk-
taking
•I will randomly select groups from both side and you
can have a debate over why your measures are more
effective
Internal Controls
•Internal controls are processes, policies, and procedures
put in place by an organization to ensure that it achieve
its objective
• Runs smoothly
• Do not break the law
• Asset protection
• Risk management
Internal Controls
•Three types of controls
• Results control: Focus on the monitoring the
outcomes/results (pay bankers according to the level of
risk at banks)
• Process control: Focus on ensuring tasks are carried
out in a specific, standardized way to achieve desired
outcomes (risk committees, chief risk officers, monthly
risk related meetings)
• Input control: Focus on regulating and monitoring
inputs in a process before work begins. The goal is to
ensure the right resources such as people, materials,
and information— are in place to achieve the desired
outcomes (hiring the right people, ensure diversity in
hiring, ensure the right information is sent to
managers)
Internal Controls from
regulators
•Three types of controls
• Results control: Capital requirements (rules that tell
banks how much money they need to keep as a safety
cushion, help banks handle unexpected problems)
• Process control: Annual stress tests (like practice
drills for banks to see if they can survive tough times,
basically simulations of a financial crisis and see if the
bank will survive)
• Input control: Not much here from regulators
Potential exam questions
Groups
•Please tell me your group on slido

Vote at slido.com with #1937360