CIMA P2 Syllabus D. Risk and Control - Nature of Risk - Notes ^{2 / 13}

Risk can be looked at in 2 ways:

1. DOWNSIDE RISK

   Things could go wrong.

2. UPSIDE RISK

   Things could go better than expected.

Categories of risk

• FUNDAMENTAL RISKS 

  are those that affect society in general and are beyond the control.

  For example, there is the risk of atmospheric pollution which can affect the health of a whole community, but which may be quite beyond the power of an individual.

• PARTICULAR RISKS 

  are risks over which an individual may have some measure of control. 

  For example, there is a risk attached to smoking and we can control that risk by refraining from smoking.

• SPECULATIVE RISKS 

  are those from which either good (upside risks) or harm (downside risks) may result.

  A business venture, for example, presents a speculative risk because either a profit or loss can result.

• PURE RISKS 

  are those whose only possible outcome is harmful. 

  The risk of damage to property by fire is a pure risk because no gain can result from it.

Negative risks

Risk management would involve minimising the chances that adverse events will happen. 

However, it may not be possible to eliminate negative risks without incurring excessive costs and insurance premiums. 

Therefore there is likely to be a level of residual or remaining risk which is simply not worth eliminating.

Risk and return

Businesses may be willing to tolerate a higher level of risk provided they receive a higher level of return. 

Indeed, a willingness to take certain risks in order to seize new opportunities may be essential for business success. 

Shareholders who themselves ultimately bear the risk of a business may welcome some risk taking.

Under this view a business should:

• Reduce risk where possible and necessary, but not eliminate all risks

• Maximise the returns that are possible given the levels of risk