Learning Module 6
Introduction to Risk Management
Key Outcomes Summary & Practice Problems
What you must be able to do
Curriculum Year: 2026
Define risk management.
Describe features of a risk management framework.
Define risk governance and describe elements of effective risk governance.
Explain how risk tolerance affects risk management.
Describe risk budgeting and its role in risk governance.
Identify financial and non-financial sources of risk and describe how they may interact.
Describe methods for measuring and modifying risk exposures and factors to consider in choosing among the methods.
1 · Risk Management Framework
Risk management — The process by which an organization or individual defines the level of risk to be taken, measures the level of risk being taken, and adjusts the latter toward the former.
Risk exposure — The extent to which underlying environmental or market risks result in actual risk borne by a business or investor.
Key elements of a risk framework — Governance, identification and measurement, infrastructure, policies and processes, monitoring and mitigation, communication, strategic analysis.
Enterprise risk management — An overarching governance approach applied throughout the organization that focuses risk activities on the objectives, health, and value of the whole organization.
2 · Risk Governance & Tolerance
Risk governance — The top-down process and guidance that directs risk management activities to align with and support the goals of the overall enterprise.
Risk tolerance — Identifies the extent to which the organization is willing to experience losses or opportunity costs and to fail in meeting its objectives.
Risk budgeting — Quantifies and allocates the tolerable risk by specific metrics; extends and guides implementation of the risk tolerance decision.
Chief Risk Officer (CRO) — Responsible for building and implementing the risk framework for the enterprise.
Component | Description |
|---|---|
Risk Tolerance | Defines acceptable vs unacceptable risks; sets the overall risk appetite |
Risk Budgeting | Allocates the risk tolerance across business units, strategies, or risk factors |
Risk Governance | Board-level oversight that ties organizational goals and risk framework together |
3 · Financial Risks
Risk arising from movements in interest rates, stock prices, exchange rates, and commodity prices.
Risk of loss if one party fails to pay an amount owed on an obligation (default risk / counterparty risk).
Risk of a significant downward valuation adjustment when selling a financial asset (transaction cost risk).
4 · Non-Financial Risks
Risk that a party fails to deliver on a payment obligation after the other party has already paid.
Risk of being sued or that contract terms will not be upheld by the legal system.
Risk of unexpected costs, penalties, or restatements due to changes in laws, rules, or accounting standards.
Risk of valuation error from improperly using a model (including tail risk from fat tails).
Risk from inadequate or failed people, systems, internal policies, and external events (cyber, terrorism, natural disasters).
Risk that the organization runs out of cash to meet obligations, even if otherwise solvent.
5 · Measuring & Modifying Risk
Risk drivers — Global and domestic macroeconomic and industry factors that create risk.
Risk metrics — Probability, standard deviation, beta, delta/gamma/vega/rho (derivatives), duration (fixed income), Value at Risk (VaR), Conditional VaR (CVaR), scenario analysis, stress testing.
VaR — Measures the minimum loss expected over a holding period a certain percentage of the time (e.g., 5% VaR of $3 million for one day).
Risk modification methods — Prevention and avoidance, self-insurance/acceptance, risk transfer (insurance), risk shifting (derivatives: forwards, futures, swaps, options).
Risk shifting — Uses derivatives to change the distribution of risk outcomes; forward commitments (obligate) vs contingent claims (options, give flexibility but require premium).
VaR = minimum loss expected with a given probability over a given horizon
Example: 5% daily VaR of £3M = expected to lose at least £3M once every 20 days.