Risk and

Risk Management
Risk
A course of action or inaction taken
under conditions of uncertainty which
exposes the risk taker to possible
loss, or gain to reach a desired
Outcome.

An undesirable situation or
circumstance that is likely to cause a
harm or a loss
Why People take Risks
 Profit
• Rewards
• Excitement
• Benefits
• Stupidity
Risk Guiding Principles
 Learning and personal growth
requires taking risks
• Take only these risks, where you
can handle the loss
• Adjust risks that are too much to
gamble with
• Accept that the price of risk is an
occasional failure
Risk tolerance
The amount of risk that is
acceptable to the individual,
organization or client

It may be different from the

individuals working in that
organization
Understanding Risk
 Risk happens as a result of a cause

 If it happens ( Probability)

 it will result in (an impact or effect).

 Uncertainty, Opportunity, Risk
Start of Completion
project of the Project

Unfavorable
Risk
Unknown
Or
Uncertainty
Favorable
Opportunity
Risk and Uncertainty
 Risk
The outcome can be described within
established confidence limits
 Uncertainty
Uncommon state of nature characterized
by absence of any information related to
the desired outcome.
Complete absence of information
Nothing is known about the outcome
You can not assign probabilities to uncertainty
 Certainty
All information for making the right
decision is available..
The outcome is predictable with
reasonable certainty
What is Risk Management?
 It is the systematic process of
identifying, analyzing and responding to
project risks. It includes actions to
maximizing the positive events and
minimizing the negative ones.

• The preparation for possible events in

advance rather than responding as they
happen.
What is the Goal of Project
Risk Management?

To forecast the various sources of risk

to a project, especially those with the
most
serious impact, and seek to reduce their
Consequences or probabilities.
Why Risk Management is
important?

 It offers significant improvement to the

final project
• Projects have better chances of success
• It improves the project schedule and
cost
• Stakeholders and team members will
better understand the nature of the
project
• It helps to define the strengths and the
weaknesses of the project
Risk Management Processes
1. Risk management planning
2. Risk identification
3. Qualitative risk analysis
4. Quantitative risk analysis
5. Risk response planning
6. Risk monitoring and control
Risk Management Planning
Deciding how to approach risk
Management for a particular project
 How

 What

 When

 How much time

 How much money

Risk Identification
 What are the things that could
go wrong ?
 What are the possible causes for things
going wrong ?
 If it does go wrong, what could be the
consequences be ?
Qualitative Risk Analysis
Performing analysis of risk and
condition to prioritize the risk that
have major impact on the project.
Quantitative Risk Analysis
 Evaluating risks and risk interaction to
assess the range of possible project
outcomes
• Measuring the probability and the
consequence of risk and estimating its
impact on the project objectives
Risk Response Development
Developing procedures and techniques
to enhance opportunities and reduce
threats to the project objectives
Risk Monitoring and Control
 Monitoring of residual risks and
new risk that may come up
during the project execution
• Execute the risk reduction plan
and
• Evaluate the effectiveness of
the risk responses developed
during the project’ planning
stage
 Measures of Risk
 Range
 Standard Deviation
 = [  pi (Xi – X)2]1/2
 Coefficient of Variation
CV = Std deviation/ Expected value
 Semi Variance
SV =  pi di2‫ ; ׳‬where di‫ =׳‬di if di <0 and di0 =‫ ׳‬if
di ≥ 0
Advanced Techniques
 Sensitivity analysis
 Scenario analysis
 Simulation
 Decision tree analysis
 Hiller model
 Break even analysis
Sensitivity Analysis - Simplified
 SA is one of the methods of analysing the risk
surrounding the capital expenditure decision and
enables an assessment to be made of how
responsive the project’s NPV is to changes in those
variables based on which NPV is computed.
 Both these determinants depends upon many
variables such as:
 Sales Revenue, Input cost, sales volume,
discount rate, competition etc.
 Given the level of these variables there can
be a set series of cash flows & hence there
will be a NPV of the proposal
 Cont…
 Thus value of an NPV is
sensitive to the said
variables in different
degrees
Parameter
 SA deals wit the
Direction
consideration of sensitivity
of the NPV in relation to Size
Increase
different variables
contributing to the NPV. Cash Flows
Decrease
 SA measures the
percentage change in Life
input parameter, which Decrease
leads to a reversal of an Discount Rate Increase
investment decision.
 Cont…
 Values of these variable parameters (inputs) are
changed to denote different situations/
assumptions
 Effects of these changes are measured on the
expected value of the outcome (cash flows) on
the value of the NPV of the proposal
 It is based on judgement of the Analyst & the
information available.
 It may be noted that sensitivity percentage does
not carry “+” or “–” sign because sensitivity
seeks to measure only the downside risks.
 Methods of Computation:
 Each input variable is considered separately
and all other assumptions are held constant.
 The extent of change in an input parameter
that would result in zero NPV is computed.
 The extent of change so determined is
expressed as a percentage.
 This process is repeated for all critical variables
to test their sensitivity.
 If a variable is likely to undergo change
beyond the levels tested, the project is
reviewed afresh.
Decision Rule:
 Sensitivity measures the downside risks.
 The formula:
Sensitivity (%) = Change/Base*100
 The lower the change percentage the
higher is the sensitivity of the project to
that input. This is because a small change
in input parameter leads to a reversal of
investment decision.
Scenario analysis
 1. select factors for building scenarios
 2. estimate values of each of the
variables in investment analysis
 3.calculate NPV/IRR under each
scenario
Selection rule
 Best scenario:High demand , best
selling Price,low variable cost etc
 Normal scenario:average demand,
average selling rice, average variable
cost etc
 Worst scenario:low demand/ low selling
rice,high variable cost etc