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Chapter 9.docx

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FIN 502
Joan Lobo

Chapter 9: Risk Management Defining Risk Speculative risk - loss/gain in uncertain amt - prob of winning/ losing - choose to accept rather than encounter f/ circumstances - all investments, shares, lottery Pure risk - possibility of loss only - early death, disability - happen w/out making conscious choice to seek them out The Risk Management Process Step 1: Identifying the Risks - life cycle stages - health and disability ← important and possible - 3 general choices: personal, life and health, property → liability to other persons for our actions that affect them - risk of liability - 3rd party liability insurance on car o harm another person → you liable for other person losses o if kill s/o → PV of lifetime earnings √≠≤≥∆∑∏←→↓↑↖↗ - material liability - ensure property → no danger to reasonable person - Torts - legal wrongs/ injuries one person causes to another - Common law - law determined by court over long period of time rather than statute o you not responsible if take reasonable care - Significant Personal Risks Risk Possible Losses Life and Stage in life Health cycle: Disability Extra exp, family duties All Stages Disability Income (limited time/permanent) 1-6 Death Income 2-5 Death Extra exp, family duties 2-5, 7 Disability Extra exp Child Property Source of risk: Rental Damage/destruction Cost of finding other accommodation (inclu hotel bill) residence Damage/destruction Repair/replacement, cost of temp accom Owned Theft/damage/destruction Repair/replacement, cost of temp replacement rental residence Automobile Theft/damage/destruction Repair/replacement, additional exp while waiting Other Assets Liability Source of risk: Unincorp bus/ Liability to 2nd, 3rd party Amt lost by other parties, legal costs Property Liability to 3rd party Amt lost by 3rd party, legal costs Chapter 6 (Table 6.1): stages are 1, single; 2, childless couple; 3,4 families w/ children; 5, older couple; 7,8 couple single retired - limited comp = liable for action/inaction → limited liability = investors not responsible beyond amt money paid for investment - unincorp bus/ $ professionals = personally liable w/ limit for all losses caused ← f/ customers, creditors, 2nd party, contractual liability, 3rd party - unlimited liability → reason small bus/ incorp ← if not, put everything they own at risk Step 2: Evaluating the Risks - Criteria: 1. size of potential loss 2. freq/ prob of occurrence 1. Size of potential loss o risk is insupportable if it materially affects family's std of living
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