RMI 2302 MID-TERM 2

Flashcard maker : Lily Taylor
Module 6
risk/reward
Individuals
Measured using expected utility
How much reward is necessary to induce you to take risk?
Similarly, how much are you willing to pay to avoid risk? This is actually the entire basis of insurance, people willing to pay to avoid risk

Organizations
Orgs. use expected value, not expected utility
No natural risk aversion
Opportunity cost or cost of capital
Most organizations project future cash flows from investments/opportunities
Discount those cash flows back to present value based on cost of capital
Cost of capital is commensurate with riskiness of firm

Gov’t/Society
Measuring reward to society is difficult (reward of national parks?)
Many times government is the only entity able to take on risk, regardless of reward

Risk/Reward
Organizations
CAPM
Only reward systemic risk
Not diversifiable risk
Efficient frontier
Bias
What is a bias?
Subjective view/probability – different from objective
Many sources
Alter the decision making
Problem when it ends up being significantly different from the model
Types of Bias
Age biases
Cultural biases
Experience biases
Gender biases
Media biases
Incentives
Now that we know how people make decisions, how do we get them to make decisions that are advantageous to us?
Incentives! Things that motivate individuals to perform an action.
Incentives can be at the individual level, organizational level, or societal level
Generally we refer to incentive structures
Types of Incentives
Financial – Most incentives
Moral – “do the right thing”
Natural – “curiosity, fear, anger, pain, joy, pursuit of happiness”
Coercive – negative reinforcement
Personal vs. social

Political Incentives
short term vs. long term planning
Discount rate

Module 6 cont.
Quiz Questions
Which of the following actions describes a way organizations use expected value?
Organizations estimate the future cash flows that are generated by an investment and then discount them back to present value.
Eric must keep a B average, or else lose his starting position on the basketball team. What type of incentive best describes this situation?
Coercive; A coercive incentive applies negative reinforcement. If Eric does not keep a B, he will lost his spot on the team. Losing his spot is the negative reinforcement.
Which of the following is a way organizations utilize opportunity cost in their calculations?
Discounting; One of the ways that organizations utilize opportunity cost or cost of capital into their calculations is through discounting.
Age biases occur when people in different age groups interpret information about risk differently.
True, Age biases occur when people in different age groups interpret information about risk differently.
At which level are incentives found?
Incentives can be at the individual, organizational or societal levels.
Which part of Secretary of State Donald Rumsfeld’s quote poses the most threat to analyzing and creating decision-making models?
“unknown unknowns”
A(n) _______ is an inclination of temperaments or outlook to present or hold a partial persepctive at the expense of (possibly equally valid) alternatives in reference to objects, people, or groups.
bias
Individuals and organizations measure risk/return with expected utility.
False, Expected utility is used for individuals, while expected value is used for organizations.
Sue is a very bright college student who stays up to date on all the news channels. In response to the number of child abductions she has seen on the news lately, she insists that her mother purchase a child harness for her younger brother. What type of bias is this?
Media, Sue has a fear that is overestimated based on media attention.
Political incentives often do what to the discount rate?
Political incentives often increase the discount rate, The discount rate is part of political incentives.
Module 7
Lots of ways (categories) of looking at risk at the individual level
Property
Liability
Life
Health
Financial
Loss Exposures
Loss Exposures
Any condition or situation that presents a possibility of loss, regardless of whether that loss actually occurs.
Three Elements to a loss exposure
Asset exposed to loss
Cause of loss
Financial consequences of the loss
Property
Asset exposed to loss
Real property
Land, buildings, crops, etc…
Personal property
Your stuff: furniture, jewelry, art, autos, watercraft, etc…
Cause of Loss
Fire, theft, windstorm, accidents, lost, pretty much anything you can think of
Financial Consequences
Reduction in property value
Increased expenses
Lost income
Liability
Asset exposed to loss
Money / other financial assets
General, Special, Punitive damages
Cause of Loss
Claim / lawsuit
Civil law vs. criminal law
Tort, contract, statutory
negligence
Financial Consequences
Defense costs
Monetary damages
Specific Types of Liability
Property owners
Automobiles
Employer-employee
Parents and children
Animals
Life – Premature Death
Asset exposed to loss
Your life
Cause of Loss
Premature death: illness, accident, stupidity
Financial Consequences
See next slide
Financial Impact of Premature Death
Wage earning adult:
Married
Single with dependents
Single with no dependents
Non-wage earning adult:
Married
Single with dependents
Single with no dependents
Child
Life – Long Life
Asset exposed to loss
Your savings / retirement / wealth
Cause of Loss
Outliving assets, expenses > income for too long
Financial Consequences
What happens when retired?
Income
Expenses
Which increase
Which decrease
Health
Asset exposed to loss
Your health, livelihood
Cause of Loss
Poor care, poor genes, bad luck, injury, illness, etc…
Financial Consequences
Ability to earn income may decrease, or cease (as in premature death)
Living expenses may continue (or increase)
Evaluate same exposure categories as premature death
Health / Disability
Asset exposed to loss
Your health, livelihood
Cause of Loss
Poor care, poor genes, bad luck, injury, illness, etc…
Financial Consequences
Ability to earn income may decrease, or cease (as in premature death)
Living expenses may continue (or increase)
Evaluate same exposure categories as premature death
Financial
Asset exposed to loss
Your wealth
Cause of Loss
Health, disability, unemployment, poor planning, etc…
Financial Consequences
Inadequate savings
Back to work
Can’t retire
Individual Risk Management
Risk Management Process
Determine Objectives
Identify Risks
Evaluate Risks
Choose your alternatives
Implement
Review & Evaluate
What are the risks?
What are the risks?
Change throughout life e.g. premature death
20’s – not many people relying on you/your income
30’s – family life changing – significant risk
40’s – your grown up (and don’t even know it) – highest this risk will ever be
50’s – risk beginning to diminish
60’s – not as big an issue
70’s – not an issue
??? – not an issue

How do you evaluate
Frequency / severity
Death only happens once, but probability does vary
Severity does vary based on
Wealth
Income

Smart Pill
What is the risk?
Insomnia, weight loss, decreased appetite, jitteriness
Increased risk of cardiovascular problems
Exacerbate depression, psychosis, anxiety
1-in-400 in doctor managed patients
Potentially addictive
10% according to 2006 study
Decreased performance over time (due to insomnia, addiction, malnutrition?)
Paranoia, aggression, irritability
What is the reward?
Improved performance on learning tasks such as memorization, especially for longer term memory (more than one day) & since education now seems to be a competitive sport…
Need to be on drug while studying, not when taking exam
Not clear you can remember more stuff at one time (working memory)
Who is using it ?
You are…
Prescription use doubled from 2007 to 2011
Studies estimate 25-35% of college students have used Ritalin, Adderall off-prescription
3-4% of population are ADHD, skewed toward younger children (many of you, if you had it, have outgrown it)
Users are also more likely to:
Smoke marijuana
Skip class
Lower GPAs
YES
Yes, they are dangerous
Alan Schwarz
Case on Richard Fee
Academic scholarship, college class president, baseball player, aspiring med school student
Addiction to Adderall – committed suicide 2 years after college

Points out problems in health care system:
Quick diagnosis
Ability to manipulate/feign symptoms
Quick to medicate
Doctor shopping

Not sure how all pharmaceuticals interact

No
Joshua Gowin
No different than other stimulants, e.g. caffeine
Just more sophisticated
They work, so use them
Module 7 cont.
Quiz Questions
The financial consequences of property risks include:

I. reduction in property value

II. increases in expenses

III. lost salary

I and II only

reduction in property value and increased expenses are financial consequences. Lost income from rental properties may also be a financial consequence, not lost salary.

Which category probably faces the largest financial impact from premature death?
single wage earning adult with dependents
In defense of “smart” pills, Joshua Gowin frequently compares them to what other cognitive enhancer?
caffeine
According to Alan Schwarz, which involved party should first change how ADHD medicine is given?
doctors
According to Joshua Gowin’s article, some university surveys have shown that up to 35% of students have obtained which two drugs as a study aid?
Adderall and Ritalin
According to Alan Schwarz in “Is the Use of ‘Smart’ Pills for Cognitive Enhancement Dangerous?”, false prescriptions of ADHD medicine is on the rise. Which of the following is not listed as being one of the dangers of false prescription?
Answers:
a. strong addiction
b. suicide/suicidal thoughts
c. increased mental awareness
d. loss of weight

Correct. Increased mental awareness.

In support of “smart” pills, Joshua Gowin introduces an anecdote of which historical event to illustrate the positive power of cognitive enhancers?
the French Revolution
In which age category do you face the highest risk of premature death?
your 40’s
Which of the following is NOT one of the five main catogories of risk faced by individuals?
a. Property
b. Liability
c. Reputational
d. Health

Correct answer c. Reputational

Alan Schwarz’s attack on “smart” pills centers around the story of _____________, a college class president and aspiring medical student who became addicted to the “smart” pill he was improperly prescribed.
Richard Fee
Module 8 cont.
Overview of Risk for Corporations
Lots of ways (categories) of looking at risk at the organization level
Business risk, operational risk, hazard risk, financial risk, strategic risk
Why categorize?
Expertise, risk management techniques, reports to stakeholders
Categories may not be mutually exclusive (some risks may appear in multiple categories)
Business risk
Investopedia does a better job than Wikipedia on this definition
http://www.investopedia.com/terms/b/businessrisk.asp
Deviations in profitability
Can be caused by many things, prices, regulation, competition, etc…
Very broad category, many will define as risk caused by operational, hazard, financial or strategic risks
Operational Risk
Focus of BP case and Analytics readings
Wikipedia is pretty good here
http://en.wikipedia.org/wiki/Operational_risk
Potential losses from internal sources
Manufacturing processes
Fraud
Mismanagement
Employee mistakes
Hazard Risk
Very traditional risk management stuff
Wikipedia not very good here (very personnel safety focused)
Typically used in insurance industry to describe potential losses that only have a down side (pure risks), e.g. fire, auto accident, tornado, earthquake, etc…
Financial Risk
Potential variation due to financial causes
Wikipedia is better than investopedia here
http://en.wikipedia.org/wiki/Financial_risk
Losses due to exchange rate, investment losses, credit risks, liquidity risks, etc…
Strategic Risks
Potential losses (variation) from poor business decisions
Product mix
Supplier choice
Financing options
Many decisions fall under “strategy”, if any of them are wrong/faulty => strategic risk
I often lump reputational risk under strategic risk, but is often a separate classification
Plenty of other categories
Legal risks
Liability risks
IT risks
Etc…
All have an impact on business some how some way
BP
Case Study
BP around 2 safety issues in 2005-2006
Overriding Themes of Case
Corporate Strategy
Public Relations
Corporate Culture
Workplace Safety
Process Management
Two Specific Incidents
March 25, 2005
Explosion at Texas City refinery
15 dead
170 injured

March 2006
Oil Spill at Prudhue Bay, Alaska (Alaskan North Slope)

Jan. 2007
CEO Browne Resigns

Background
BP formed in 1998
Merger of British Petroleum & AMOCO
Top 5 Global Oil Co.
British Petroleum
Over 100 years old
Browne became CEO in 1995
Rebranding
Environmentally friendly oil company
Health, Safety, & Environmental (HSE) performance
Growth through M
Green Company – Climate Change talk in 2002
Alternative Fuels
Solar
Public Relations Perspective
Increase in brand value
Many lauded BP’s approach
Some critics
“greenwashing”
How can an oil company be “green”?
cont.
Corporate Strategy Perspective
Growth through M&A
“Do more with less”?
Cost cutting?
Cost conscious?
What effect does Corporate Strategy have on Corporate Culture? Workplace Safety? Process Management?
1st event
March 23, 2005
Explosion @ Texas City Refinery
15 dead
170 injured
1,700 lawsuits
Was safety first
OSHA
$21.3M fine by OSHA
300 willful violations of OSHA rules
US Chemical Safety & Hazard Investigation Board (CSB)
BP endangered workers to cut costs
23 accidents in 30 years
8 “severe” incidents in 10 years leading up to explosion

CSB Report Con’t:
“Lack of safety leadership”
“inadequate resources for safety”
“independent panel to review safety”
BP response
“we may not have broken laws, but broke our values”
Baker report – not finished until Jan. 2007

Second Event
March 2006
Leak discovered in Prudhoe Bay, Alaska
Largest US oilfield (Alaska North Slope)
267K gallons, largest spill in this oilfield
Comparison Exxon Valdez approx. 30M gallons
Comparison Deepwater Horizon 210M gallons
Corroded pipe
BP response – shut down oil fields
8% drop in US oil production
16 of 22 miles of pipe needed to be replaced
was safety firstt
Pipeline and Hazardous Materials Safety Administration
“ineffective leak detection system”
Pipeline had several defects (internal corrosion)
BP used a different inspection system (UT technology vs. pipeline inspection guages (PIG))
Browne Steps Down
January 12, 2007
Browne will step down as CEO in July 2007
4 days before Baker report released
Widely recognized as one of Great Britain’s top businessmen
Financial Legacy: M & A, rebranding, 5X increase in profits and market cap, 2.5X increase in share price
The Baker Report
January 16, 2007
Critical of BP’s approach to process safety
Failed to give process safety the same emphasis as other initiatives including environmental and other safety initiatives
Should have paid more attention to previous incidents (chemical releases & fires)
Refineries did not get the same importance as exploration
Decentralized management and entrepreneurial culture delegated substantial discretion to plant managers without outlining expectations regarding process safety, responsibility, or accountability

Communication lacking
Contract vs. union workforce problems
“instances of lack of operating discipline, toleration of serious deviations from safe operating practices, and complacency”
Not restricted to BP

10 recommendations
10 recommendations
1.Process safety leadership (top down)
2.Process safety management system
3.Process safety knowledge and expertise
4.Process safety culture
5.Clearly define expectations and accountability for process safety
6.Support for line management
7.Leading and lagging performance measures for process safety
8.Process safety auditing
9.Board monitoring
10.Industry Leader
BP: The Follow-up
Integrity was questioned
One year “worst refinery accident” & “worst oil spill”
“bloated profits”
“bad pipelines”
Failed to communicate what was important
Cost, safety or environment
Did org structure allow it to do what is necessary?

2010
Toxic gas release at Texas City refinery that lasts 40 days (sold in 2013)
Deepwater Horizon Oil Spill
Cause: cost-cutting?

Big Data Overview
Big Data
We create so much data today, how can organizations use it?
Data mining
Buying trends
Targeted marketing
Mitigate risky business practices, employee fraud (operational risk), & black swans
Most risk management
Use past data to predict future risks
“risk landscape is changing so fast, that historic data is no longer a good predictor for tomorrow”
Article is presented as a Q
Business risk, operational risk, black swans, and behavioral analytics
What are the different types of risk organizations need to think about, from operational risk to the so-called black swans?
Operational risk – the people, processes, and systems in place to produce the company’s product/service
Internal fraud, external fraud, products & business practices, damage to physical assets, business disruption, system failures, process management, employment practices, workplace safety
What is a black swan risk?
An extreme outlier: high impact, hard-to-predict, rare events that generally people don’t expect.
E.g. Bernie Madoff, mortgage crisis
How has risk changed in recent years?
Globalization, cascading network effect
Operational risk – 30% of business loss
Where does data analytics fit in?
Tools to predict areas of vulnerability in organizations to black swans and other kinds of risk
Look for markers of situations where human behavior can impact operational risk
Look for factors that influence human behavior
Laziness, fatigue, moral or ethical “opportunities”, stressors (debt, job concerns, family issues)
Could data analytics have helped BP?
There were reports that on-site employees were worried about such an event, but no channel to communicate
BP didn’t monitor systems closely, costly to do so, cut corners
Future of behavioral analytics?
Systems are pretty good at looking for potential risks ignoring the human element
Behavioral analytics adds that examination of the human component, mixed with statistics and external analysis
More complete or “intelligent” risk analytics.
Module 8
Quiz Questions
The people, processes, and systems in place to produce the company’s product/service describes which of the following risk categories?
operational
Which of the following terms best describes a rare, unexpected event (e.g., the discovery of alien life on Mars)?
black swan
Business risk can encompass which of the following?
operational
hazard
strategic

all of the above

The reading on behavioral analytics discussed the possibility of fraud can be within which of the following categories?
operational
In the case discussed in class, we identified some overriding themes. Which of the following was NOT one of the overriding themes?
Correct answer; managerial efficiency
Answers:
a. corporate strategy
b. workplace safety
c. corporate culture
d. managerial efficiency
Which investigative body concluded that BP endangered workers to cut costs?
US Chemical Safety & Hazard Investigation Board (CSB)
Which of the following was NOT included in the 10 recommendations from the Baker Report?
additional expertise within workforce
process safety culture
support for line management
board monitoring

Correct additional expertise within workforce

Sally desperately wants to open her own nail salon. She decides to open on the north side of town, which she did not realize receives relatively little traffic. Which category would this error fit under?
strategic
What types of alternative fuels did BP pursue after Browne became CEO in 1995?
Solar
Which of the following is an example of a hazard risk?
flood
Module 9
According to “From Superstorms to Factory Fires”, the author was surprised to find what kind of correlation between how much a firm spends annually on procurement at a particular site and the site’s impact on company performance? ch.9
little correlation
In “From Superstorms to Factory Fires”, what was Ford able to do using the model described in the article? ch.9
Using the model, Ford was able to identify the supplier sites that required no special risk-management attention.
In “Strategy, Risk, and the Global Financial Crisis”, Walter Keichel argues that a fair-minded observer would conclude which of the following statements in regards to the financial crisis?
While strategy and its champions may not have been a main cause in bringing on the global financial crisis, they did not do much to avert it.
In “Strategy, Risk, and the Global Financial Crisis”, what was a major difficulty encountered by Boston Consulting Group when the firm canvassed Indian, Japanese, European, and American firms?
Firms were unwilling to implement a strategy, replying “We don’t do strategy”.
The following statement describes which of the following theories? “_________ is a theory of management that analyzes and synthesizes workflows. Its main objective is improving economic efficiency, especially labor productivity.”
Taylorism
Which of the following is a primary benefit of using the linear optimization model?
The model reveals supply chain dependencies and bottlenecks.
Which of the following is not an example of PI (performance impact)?
a.lost units of production
b.profit margin
c.Correct unemployment rate
d.revenue
Which of the following is not described in “Strategy, Risk, and the Global Financial Crisis?” as being part of the “constellation” of forces responsible for the blurring of traditional industry lines?
a.deregulation
b.competition from new quarters
c.new technologies
d.Correct interest from investors
Which of the following is not true about REI scores?
a.The node with the largest performance impact is assigned an REI.
b.REI allows a firm to identify at a glance the nodes that should get the most attention from risk managers.
c. Correct REI scores help determine macroeconomic effects of monetary policy.
d.A node whose disruption would cause the least impact receives an REI value close to zero.
Which of the following provides the clearest description of time to recovery (TTR)?
a.the time it takes for knowledge aggregation
b.Correct the time it would take for a particular node to be restored to full functionality after a disruption
c.the time it takes for analysis to be conducted following an external shock
d.the time it takes to analyze hidden exposure and recover from those errors

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