Page 26 - Risk Management in current scenario

A first step in this direction is to identify the risk and prioritize between
the material and immaterial risk and focus on material risk. Determine
how to model and quantify those key risks. This could be performed using
stochastic modeling. 0ne of the methods often used for risk assessment
is Value at Risk (VaR) which gives rise to economic capital for each risk
pre-diversification and allow diversification effect to arrive at Company
level economic capital. The value at risk is calculated as maximum loss
that a company can face at a given confidence level (99%) within certain
time frame (a day or a year).

Once the capital is allocated, there is a need to look at the return on capital.
The shareholder's interest is to minimize the variance of the return to stay
ahead in the capital market, for this purpose the Board must define and
pre-fix the risk appetite (the standard deviation on the return) to maximize
the return on the portfolio for the management to focus on. The expected
return on the portfolio can be found from capital market line given the
risk appetite std(A) on the portfolio as E(P) = r+ [E(m)-r)/Std(m), std(A) is
the risk free rate and E(m) and Std(m) is the mean and standard deviation
on the market.

Using this risk and return trade off at an enterprise level helps in taking
the decision on which projects/products to allocate capital and which one
not.

So the objective is achieving the return on the capital as E(P) given the
risk appetite Std(A) in making the decision at a Company level for different
jobs and projects within the company may be broken down into small
projects such that the weighted return is E(P) and overall risk is Std(A).
Essentially, while the management is focusing on the upside opportunity,
CRO is focusing on std(A) and tail risk. Any return over and above the
E(P) while staying within the risk appetite is the value addition to the
shareholders. Risk management comes here handy in enhancing the
shareholder value addition through helping in deciding which projects,
which products, which decision to make and accept the risk. In the

24 | Risk Management in Current Scenario