Chapter 1 Review Questions

List the major types of pure risk that are associated with economic insecurity.

--premature death --inadequate retirement income --poor health --unemployment

Explain the historical definition of risk.

Historically, risk is defined as uncertainty concerning the occurrence of a loss.

What is the difference between objective probability and subjective probability?

Objective probability: long term relative frequency of an event based on the assumption of an infinite number of observations and no change in underlying conditions. Subjective probability: individuals personal estimate of the chance of loss.

What is a financial risk?

a risk that business firms face because of adverse changes in commodity prices, interest rates, foreign exchange rates, and the value of money.

Explain the meaning of enterprise risk

a term that encompasses all major risks faced by a business, including pure risks, speculative risks, strategic risks, operational risks, and financial risks.

What is loss exposure?

any situation or circumstance in which a loss is possible, regardless of whether a loss occurs

Briefly explain each of the following risk control techniques for managing risk.

--Avoidance: avoiding high risk situations --Loss Prevention: reduces the probability of loss so that the frequency of losses is reduced --Loss reduction: reduce the frequency of losses --Duplication: have back ups or copies of important documents or property available in a case of loss. --Separation: assets exposed to loss are separated or divided to minimize the financial loss from a single event. --Diversification: Spread the loss exposure across different parties.

Explain the difference between direct loss and an indirect or consequential loss.

--Direct Loss: defined as a financial loss that results form the physical damage, destruction, or theft of a property. --Indirect Loss: a financial loss that results indirectly from the occurrence of a direct physical damage or theft loss.

How does diversifiable risk differ from nondiversifiable risk?

--Diversifiable risk: a risk that affects only individuals or small groups and not the entire community. --Nondiversifiable risk: a risk that affects the entire economy or large number of persons or groups within the economy which cannot be reduced or eliminated by diversification.

How does objective risk differ from subjective risk?

--Objective risk: degree of risk: the relative variation of actual loss from expected loss --Subjective Risk: perceived risk: uncertainty based on a persons mental condition or state of mind.

What is the difference between peril and hazard?

--Peril: actual cause of loss --Hazard: any condition that increases the possibility of a loss.

Define physical hazard, moral hazard, attitudinal hazard, and legal hazard.

--Physical Hazard: Physical condition that increases the chance of loss --Moral Hazard: Dishonesty or characer defects in an individual that increase the frequency of severity of loss. --Attitudinal Hazard: Carelessness or indifference to a loss, which increases the frequency or severity of a loss. --Legal Hazard: Characteristics of the legal system or regulatory environment that increases the frequency or severity of losses.

Explain the difference between pure risk and and speculative risk

--Pure Risk: situation in which there are only the possibilities of loss or no loss. --Speculative risk: defined as a situation which either profit or loss is possible.

Briefly explain each of the following risk financing techniques for managing risk

--Retention: individual or a business firm retains part of all of the losses that can result from a given risk. --Non-insurance Transfers: transferred to a party other than the insurance companies --Insurance: covers risks.

Describe the major social and economic burdens of risk on society

--The size of an emergency fund must be increased.; in the absence of insurance, individuals and business firms would have to increase the size of their emergency fund to pay for unexpected losses. the higher the amount that must be saved, the more current consumption spending must be reduced, which results in a lower standard of living --Society is deprived of certain goods and services.; Because of the risk of a liability lawsuit, many corporations have discontinued manufacturing certain products. --Worry and fear are present; the mental unrest and fear caused by risk

How does enterprise risk management differ from traditional risk management?

--Traditional risk management (RM) considers only hazard and operational risk that can affect an organization; considers pure risk; seeks to prevent or reduce risks related only to losses --Enterprise: wide risk management (ERM) expands an organization's risk focus to include financial and strategic risk, allowing it to account for all eventualities that can affect its ability to achieve its goals; considers both pure and speculative risk; seeks to optimize risk taking relationship to strategic goals

Identify the major risks face by business firms.

--commercial risks --property risks --loss of business income --cybersecurity and identity theft.

What is enterprise risk management?

comprehensive risk management program that considers an organization pure risks, speculative risks, strategic risks, and operational risks.

Define chance of loss.

the probability that a loss will occur.