Table 1.docx

Table 1.2 Types of Possible Risks in developed and Emerging Markets Type of Risk Description Country risk

Credit risk Market risk

Sovereign risk

Political risk

Industry risk Reputational risk Accounting risk

Liquidity risk Business risk

Operational risk

Legal/regulatory risk Systemic risk

Environmental risk

the risk that a foreign currency will not be available to allow payments due to be paid because of a lack of foreign currency or the government rationing what is available. the risk that a counterparty may not pay amounts owed when they fall due the risk of loss due to changes in market prices. This includes interest rate risk, foreign exchange risk, the credit risk associated with lending to the government itself or a party guaranteed by the government (not to be confused with country risk). the credit risk associated with lending to the government itself or a party guaranteed by the government (not to be confused with country risk). the risk that there will be a change in the political framework of the country. the risk associated with operating in a particular industry. the risk that the reputation of an organization will be adversely affected. the risk that financial records do not accurately reflect the financial position of an organization. the risk that amounts due for payment cannot be paid due to a lack of available funds. the risk of failing to achieve business targets due to inappropriate strategies, inadequate resources or changes in the economic or competitive environment. the risk of loss due to actions on or by people, processes, infrastructure or technology or similar which have an operational impact including fraudulent activities. the risk of non-compliance with legal or regulatory requirements the risk that a small event will produce unexpected consequences in local, regional or global systems not obviously connected with the source of the disturbance. the risk that an organization may suffer loss as a result of environmental damage caused by themselves or others which impacts on their business.

Affected Investment All types including Foreign investments

Fixed Income security All types

Mostly bonds

All types especially smaller foreign countries All types Limited to organisation policy Any types especially in a less stable foreign country All types All types

All types

Limited the law and policy of the country All types

All types

Table 1.1 presents illustrate the milestones of risk analysis and evolution of risk measures

Period Pre-1494 1494 1654 1662 1711

1738 1763 1800s 1875

1900

1952

19611966

1976 1980

1986 1992

2009

Key events Fate or divine providence altered through prayers and sacrifice The coin tossing puzzle by Luca Paccioli Blaise Pascal and Pierre de Fermat solve Paccioli’s puzzle, lay the foundation for Probability estimation and theory John Graunt developed the Life table using data on birth and death in London Jacob Bernoulli’s Ars Conjectandi develops the law of numbers providing the basis for sampling from large populations. Abraham de Moivre suggests derives the normal distribution as an approximate to binomial and Gauss & Laplace refine it. Thomas Bayes publish Treatise on how to update prior beliefs as new information is acquired. Insurance business develops, and it come an actuarial measure of risk, based upon historical data Francis Galton describes regression toward the mean. When one makes any decision based on the expectation that matters will return to “normal”, one is employing the notion of regression to the mean Louis Bachelier examines stock and option price on Paris exchange and defends his thesis that price follow a random walk Harry Markowitz demonstrates mathematically why putting all your eggs in one basket is an unacceptable risk strategy and why divarication is important, igniting an intellectual movement that revolutionized corporate finance, and business decisions around the world Working upon the foundations of diversification and modern portfolio set by Harry Markowitz, Sharpe, Lintner and Mossin independently develop the Capital Asset Pricing Model (CAPM) which is a model used to determine a theoretically appropriate required rate of return of an asset, to make decisions about adding assets to a well-diversified portfolio. Stephen Ross derive the arbitrage price model multiple risk factors are derived from the historical data Value-at-Risk (VaR) is disseminated. VaR is a measure of the risk of loss for investments. It is the maximum value that a portfolio or company can lose during a given period of time, at specified level of confidence. This also allows one to measure the optimal capital required to protect companies or portfolios from the anticipated and unanticipated losses. Macroeconomic variable examined as potential market risk factors leading to multi-factor model. Kent D. Miller in the paper named “A Framework for Integrated Risk Management in International Business” published in the Journal of International Business studies, suggests a framework for categorizing the uncertainties faced by firms operating internationally and outlines both financial and strategic corporate risk management responses (ISO) publishes ISO 31000 – Risk management – Principles and guidelines, provides principles, framework and a process for managing risk that can be used by any organization, regardless of its size, activity or sector

Risk measure used beleifs Guts feeling Computed probabilites Life table Sample-based probability

Normal distribution Bleeding new ideas with old ideas Expected loss regression toward the mean

Price variance

Variance added to portfolio

Capital Asset Pricing Model (CAPM) Market Beta

Factor Beta portfolio theory

Macroeconomic beta Proxies

ISO 31000

Table 1.2 The Disciplines, Risk, and Knowledge Forms Applied to the Unknown that Determine Disciplinary Epistemological Definitions of Risk How risked is viewed

Knowledge applied to the unknown

discipline

Risk is calculable phenomenon

calculation

Mathematic and logic

Risk as an objective reality

Principle postulate and calculations

Science and Medicine Social science:

Risk as a cultural phenomenon

Culture

Anthropology

Risk as a social phenomenon

Social construct or frameworks

Sociology

Risk as a decision phenomenon away

Decision-making principle and postulate

Economics

Rules

Law

Cognition

Psychology

Terminology and meaning

Linguistics

of securing wealth or avoiding loss Risk as a fault of conduct and judicable phenomenon Risk as a be behavioral and cognitive phenomenon Risk as a concept

History and the humanities Risk as a story

Narrative

History

Risk as an emotional phenomenon

Emotion

The

Arts

(literature,

poetry theatre art etc. Risk as an act of faith

Revelation

Religion

Risk as a problematic phenomenon

Wisdom

Philosophy

music

Type of Risk

Description

Affected Investment

Country risk

the risk that a foreign currency will not be available to allow payments due to be paid because of a lack of foreign currency or the government rationing what is available. the risk that a counterparty may not pay amounts owed when they fall due the risk of loss due to changes in market prices. This includes interest rate risk, foreign exchange risk, the credit risk associated with lending to the government itself or a party guaranteed by the government (not to be confused with country risk). the credit risk associated with lending to the government itself or a party guaranteed by the government (not to be confused with country risk). the risk that there will be a change in the political framework of the country.

All types including Foreign investments

Credit risk Market risk

Sovereign risk

Political risk

Industry risk Reputational risk Accounting risk

Liquidity risk Business risk

Operational risk

Legal/regulatory risk Systemic risk

Environmental risk

the risk associated with operating in a particular industry. the risk that the reputation of an organization will be adversely affected. the risk that financial records do not accurately reflect the financial position of an organization. the risk that amounts due for payment cannot be paid due to a lack of available funds. the risk of failing to achieve business targets due to inappropriate strategies, inadequate resources or changes in the economic or competitive environment. the risk of loss due to actions on or by people, processes, infrastructure or technology or similar which have an operational impact including fraudulent activities. the risk of non-compliance with legal or regulatory requirements the risk that a small event will produce unexpected consequences in local, regional or global systems not obviously connected with the source of the disturbance. the risk that an organization may suffer loss as a result of environmental damage caused by themselves or others which impacts on their business.

Fixed Income security All types

Mostly bonds

All types especially smaller foreign countries All types Limited to organisation policy Any types especially in a less stable foreign country All types All types

All types

Limited the law and policy of the country All types

All types

Managing risk result in greater reruns. The understanding of risk have changed and is developed over time. It is radically different from what it was in the past and it is expected to keep changing. Our ability to manage risk effectively is dependent firstly on being able to identify potential risks, and secondly being able to measure those risks. This is easier said than done. For some areas, credit and market risk for example, there are well developed industry standard tools and techniques but as we move across the spectrum of risk, the degree of difficulty increases and, as yet, there is no industry standard for measuring risks across risk categories. We have explained some of the common tools in use but to a large extent we will need to rely on simple measures, such as aggregate exposures and trend analyses, in emerging markets because of the quality of data available. Plus, there is less confidence in the predictive value of models in volatile environments. Blindly following an inappropriate model is as risky as having no model at all. Going forward there is a need to continue to develop theories and models but much can be done to improve the quality of risk measurements simply by ensuring that things such as data standards are clearly defined, and that systems and incentives are in place to improve the quality of data flowing through to decision makers. As we rely more and more on data for measuring risks, and technology enables us to look into risk areas from afar, this will become more and more important. Risk management starts with setting the right strategy. strategy setting must involve risk and must not be dictated from the top. A robust risk framework is needed to support the strategy. The more aggressive the strategy the more important the risk framework becomes. Historically, risk has been managed from the centre (command and control) but this is not the most appropriate model in an increasingly volatile environment. Decentralization will help risk management operate more effectively at the front line, but controls are still needed, as are better quality people. The types of risk management frameworks adopted will vary according to size and complexity of the organization. Whatever the type of risk framework adopted there are a number of key elements that need to be addressed, including checks and balances, policies and processes, limits and roles and responsibilities. There are many tools and techniques for managing risk but often they simply transform the risk rather than eliminate it and, in many, create new risks. Doing it right will lead to satisfactory rewards but failure to address risk effectively will lead to losses and eventual demise, the only question being whether death is quick or slow. Building a robust framework is not sufficient. People issues and risk culture must be addressed. The right strategy supported by a robust risk framework which is implemented well will reduce the probability of an organization being hit by unexpected events and will help minimize the impact of any adverse events. It will not eliminate the risk of fraud.

Emerging markets are defined as those countries which have started to grow but have yet to reach a mature stage of development and where there is significant potential for economic or political instability. This definition covers a broad range of countries but excludes those which are at the bottom of the development prospect list. There is no typical emerging market, but they have a variety of characteristics in common which, one way or another, make them weak or vulnerable to internal or external shocks. Given this large number of countries it is useful to group them together or rank them using a variety of methodologies depending on the purpose. Despite their various weaknesses that emerging markets exhibit, there has been progress in a number of areas in the past 10 to 20 years Improvements have resulted from changes internally, particularly attitudes to outside investors, but also due to markets maturing in developed countries and costs of production rising. Pull and push factors have combined to increase the level of interest in emerging markets as target markets as well as production bases. This increased level of interest has been facilitated by technology, communication and transportation improvements. The Asian crisis, amongst others, has highlighted the degree to which fundamental change has, or has not, happened in the various markets. It has helped accelerate some positive developments, but the pressure has been reduced recently, which gives cause for concern. There is now general recognition that inward investment is a key to increased growth and that to attract investment change is needed. To investors this is good news, but apparent high levels of rewards only come with higher levels of risk. Understanding those risks up front is necessary to avoid expensive mistakes. Understanding culture is vital if risk is to be managed effectively in emerging markets. The need for this has changed significantly as we have moved from a colonial command and control environment to one where persuasion, rather than power, is required to get results. We have defined culture as “the way a group of people solves problems". Culture drives behaviour, it is what we learn not what we are born with. We are all subject to a number of cultural influences – tribal, region, organization, etc. When faced with problems we may experience conflicts between different cultural influences. How these conflicts are resolved will be determined by the relative strengths of the various cultural influences. The stronger cultural influences are likely to be those we have been exposed to longest – nation, family, religion. Organizational cultures are more transient and less deep seated, unless particularly strong. Culture operates at a number of levels – basic assumption, norms and values, and explicit products. There are a number of dimensions that can be used to explain cultural differences such as whether groups or individuals are more important, whether position is influenced more by achievement or ascription, and the relative importance of the past, the present and the future in determining actions. The combination of these dimensions will define, say, a national culture but not everyone will act or behave in the same way. Beware of stereotyping people. Within organizational cultures are determined by the actions and

deeds of senior management. Strong cultures will develop where these are clear and there is consistency, but weak where what they do conflicts with what they say. Strong organizational cultures take a long time to develop but can be undermined very quickly. Where the strategy of an organization is at odds with market opportunities the organizational culture will determine how this is resolved. Actions taken by managers which go against cultural norms or values are likely to provoke a reaction. Sometimes this is obvious and immediate. In other cases it is subtle and may not be evident for a long time. Western influences are becoming more pervasive as satellite TV and internet access spreads, causing aspirations to rise and leading to conflicts with traditional values. Those exposed to developed country cultures through periods of study are also driving change in cultural values. When faced with problems we may experience conflicts between different cultural influences. How these conflicts are resolved will be determined by the relative strengths of the various cultural influences. The stronger cultural influences are likely to be those we have been exposed to longest – nation, family, religion. Organizational cultures are more transient and less deep seated, unless particularly strong. Culture operates at a number of levels – basic assumption, norms and values, and explicit products. There are a number of dimensions that can be used to explain cultural differences such as whether groups or individuals are more important, whether position is influenced more by achievement or ascription, and the relative importance of the past, the present and the future in determining actions. The combination of these dimensions will define, say, a national culture but not everyone will act or behave in the same way. Beware of stereotyping people. Within organizational cultures are determined by the actions and deeds of senior management. Strong cultures will develop where these are clear and there is consistency, but weak where what they do conflicts with what they say. Strong organizational cultures take a long time to develop but can be undermined very quickly. Where the strategy of an organization is at odds with market opportunities the organizational culture will determine how this is resolved. Actions taken by managers which go against cultural norms or values are likely to provoke a reaction. Sometimes this is obvious and immediate. In other cases, it is subtle and may not be evident for a long time. Western influences are becoming more pervasive as satellite TV and internet access spreads, causing aspirations to rise and leading to conflicts with traditional values. Those exposed to developed country cultures through periods of study are also driving change in cultural values. Conclusion The world is not static but changing rapidly and at an ever- increasing pace. Increased interconnectedness means that we face new risks every day, not least in emerging markets. To respond to the increased levels of risk, risk

management disciplines have spread across many industries and there are now many more risk professionals. Despite the growth in the number of risk professionals, responsibility for managing risk lies firmly with line management, risk professionals provide support. The types of risks that businesses face is more pervasive and require cross-border co-operation to solve. The ability of governments to deliver is, however, limited and not improving. There are many drivers of change, some are creating new opportunities in emerging markets particularly in technology. Looking forward we can expect that current trends such as globalization, increased complexity, greater volatility, and so on will continue but there will undoubtedly be some unexpected events. To help managers of risk, tools and techniques will continue to develop and will encompass more of the risk areas that are difficult to quantify today.