FIN 512 Chapter Notes - Chapter 1: Operational Risk, Credit Risk, Social Insurance

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16 Oct 2011
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Chapter 1 Risk, risk management and insurance
Principles
1. Law of large numbers insurance companies can charge small premiums for large loss
exposures
2. An insurance policy is a contract
Risk/return Tradeoffs- The more risk one is willing to accept, the higher the possible return
Risk management- Limiting the size of the bet so you are not wiped out if you take the wrong
side
Risk - An uncertainty about the occurrence of a loss
Exogenous risk- Risk that we have no control of
Endogenous risk- Risks that we CAN control
Objective risk - risk that is determined by analysing past experiences
Standard deviation - average difference of each loss from the average
Subjective risk
- the uncertainty is based on a person’s mental condition and the subjective probability is
based on an individual’s personal estimate of a chance of loss
- use inductive reasoning to come to conclusions about objective risks
- use deductive reasoning where the probability is obvious
Pure risk- where there is a chance of loss or NO gain insurable
Speculative risk -possibility of a loss and a gain not insurable ( they involve voluntary
acceptance)
3 categories of pure risk
1. property risk
a. Direct loss damage to or loss of property
b. Indirect loss e.g. need to rent another space
2. Personal Risk
3. Liability risk
Pure risk for business
1. Financial risk
2. Credit risk
3. Operational risk
4. Strategic risk
5. Risk to reputation
Dynamic risk changes in the country and are insured by gov’t
Static risk for of pure risk, not connected to changes in economy
Fundamental risk affects a large number of people cal occurrences
Particular Risks affect only individuals and not a large group
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