Enterprise Risk Management (ERM)

• Enterprise Risk Management (ERM) manages an organization's risks and opportunities to boost shareholder value.
• ERM considers pure, speculative, strategic, and operational risks.
• ERM identifies, assesses, and manages risks within an organization’s risk appetite to achieve its goals.
• The primary goal of ERM is to minimize unexpected earnings volatility and maximize firm value.
• Risk is uncertainty concerning the occurrence of a loss.
• Two meanings of risk are greater expected loss and less predictability of outcomes.
• The risk-return tradeoff links higher risk with potentially higher returns but also greater uncertainty.
• The key steps in risk management are to identify, assess, manage, and continuously monitor risks.
• Price risk is uncertainty over cash flows due to changes in output and input prices like commodity or exchange rates.
• Credit risk is the risk that customers or borrowers will delay or fail to make payments.
• Pure risks involve only loss or no loss, like asset damage, legal liability, or worker injuries.
• Direct losses result from a peril, while indirect losses are financial consequences of a direct loss.
• The main goal of risk management is to minimize the total cost of risk (TCOR) and increase firm value.
• TCOR includes outlays to reduce risk, opportunity costs, expenses from financing losses, and costs of unreimbursed losses.
• Risk management increases firm value by decreasing unexpected losses, reducing cash flow volatility, and improving decision-making.
• Risk managers buy insurance, identify risks, design loss control programs, ensure compliance, conduct training, and manage claims.
• The four common categories of enterprise risks are hazard, financial, strategic, and operational.
• Hazard risks include natural disasters, fires, workers' compensation, and environmental liabilities.
• Financial risks include interest rate fluctuations, credit risk, economic recession, and changes in tax laws.
• Strategic risks include market share battles, mergers, regulatory changes, and negative media attention.
• Operational risks include IT failures, business interruptions, loss of key personnel, and health and safety violations.
• A siloed approach manages risks separately by department, while ERM integrates risk management across the organization.
• Natural hedges are risk offsets that reduce overall risk exposure by balancing one risk against another.
• ERM efforts are typically led by a Chief Risk Officer (CRO) or an ERM committee.
• ERM helps businesses anticipate, mitigate, and manage risks that could impact their success and sustainability.

Risk Questions & Terms

• The standard deviation of losses for liability-related losses of $5M, $14M, and $32M is between $10 million and $15 million.
• The risk associated with investing in bitcoin is NOT a pure risk.
• Objective risk best describes the relative variation between what is expected and what actually occurs.
• Big Bend Financial lends $1M to EHDI, which then faces a lawsuit and is unable to repay is an example of credit risk.
• Fred’s Food Products relies on wheat, soy, and corn face commodity price risk.
• Steve’s Scuba Gear’s building being destroyed by a hurricane and resulting in rental of a temporary location is an example of indirect (consequential) loss.
• The statement that the primary objective of risk management is to avoid all risk is false.
• Excelsior Industries buys machinery for 700,000 GBP when the exchange rate is 1 USD = 0.81 GBP, how much USD do they pay: and the answer is More than $800,000.
• A SpaceCor rocket explodes due to extreme low temperatures, with the explosion as the peril.
• Florence intentionally damages her delivery van to claim insurance benefits; this is considered a moral hazard.
• Risk identification is the process of finding, recognizing, and describing risks that could impact an organization.
• Risk identification ensures a firm takes the right amount of the right kinds of risk to maximize value.
• Common sources of risk include the physical, legal, political, and economic environments.
• Process mapping identifies risks by analyzing business processes and identifying bottlenecks.
• Contract analysis reviews contractual agreements to identify potential liabilities and risks.
• Statistical loss data analysis evaluates historical loss data to identify patterns, frequency, and severity of risks.
• Root cause analysis determines the underlying causes of risks by analyzing past incidents.
• Risk evaluation analyzes risks to determine their likelihood and impact.
• Factors commonly used to assess risk are impact (severity), likelihood (frequency), vulnerability, and speed of onset.
• Qualitative methods of risk assessment include workshops, interviews, surveys, benchmarking, and expert judgment.
• Quantitative methods of risk assessment include statistical modeling, probability distributions, scenario analysis, and value-at-risk calculations.
• The law of large numbers states that as the number of exposure units increases, the degree of objective risk decreases.
• Expected value is the average outcome based on probabilities of different risk scenarios.
• Standard deviation measures variability and indicates the expected magnitude of deviation from the average outcome.
• Maximum Probable Loss (MPL) is the estimated maximum loss a company could suffer with a specified confidence level.
• Value at Risk (VaR) estimates the worst expected loss under normal market conditions over a set time period.
• A correlation matrix shows how different risks interact and whether they are positively or negatively correlated.
• A risk heat map visually plots risks based on likelihood and impact to help prioritize risk management efforts.
• Risk prioritization ranks risks based on their impact, likelihood, and other important factors.
• The coefficient of variation compares variability between two or more separate distributions.
• Risk forecasting predicts future risk exposures using statistical models and historical data.
• Discounted cash flow (DCF) analysis evaluates the financial impact of risk-reducing investments by calculating present value.
• ERM views risk interactions through an integrated approach, recognizing that risks interact and should be managed holistically.
• Scenario analysis examines different potential risk scenarios and their impact on business objectives.

Enterprise Risk Management (ERM) is a framework for managing an organization's risks and opportunities to boost shareholder value. The primary goal of ERM is to minimize unexpected earnings volatility and maximize firm value by identifying, assessing, and managing risks.