Alternatively it could be thought of from the

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Alternatively, it could be thought of from the perspective of an entity changing its business strategy compared to its competitors. For example, a financial institution may choose to change its lending focus from lending to stable firms and attempt to lend funds to risky firms at high rates of interest in order to earn higher profits. However, an economic crisis ensues and many of those risky firms default on their loans, leading to large losses to the lending financial institution. The impact of strategic risk will be felt by an entity if its business decision has an unsuccessful result, thereby incurring large losses and loss of reputation/confidence by investors. Reputation Risk Reputation risk consists of two parts: (1) the general perceived trustworthiness of an entity (i.e., that the entity is able and willing to meet its obligations to its creditors and counterparties) and (2) the general perception that the entity engages in fair dealing and conducts business in an ethical manner.
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Page 10 ©2015 Kaplan, Inc. Topic 1 Cross Reference to GARP Assigned Reading – Crouhy, Galai, and Mark, Chapter 1 Reputation risk could arise partly due to the existence of the internet. For example, social networking sites and blogs could allow for rumors—true or false—to be spread about an entity very quickly. An entity’s involvement in questionable and sophisticated financial transactions such as structured finance products or special purpose entities may give rise to reputation risk for an entity because the interpretation of the accounting and tax rules related to such transactions may be misleading and border on illegal in some cases. The impact of reputation risk on an entity could start with lost profits and eventually lead to insolvency as public perception of the entity diminishes together with the value of the entity.
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©2015 Kaplan, Inc. Page 11 Topic 1 Cross Reference to GARP Assigned Reading – Crouhy, Galai, and Mark, Chapter 1 K EY C ONCEPTS LO 1.1 Risk arises from the uncertainty regarding an entity’s future losses as well as future gains. Risk management includes the sequence of activities aimed to reduce or eliminate an entity’s potential to incur expected losses. Risk taking refers specifically to the active assumption of incremental risk in order to generate incremental gains. LO 1.2 In its basic format, the risk management process is as follows: Step 1: Identify the risks. Step 2: Quantify and estimate the risk exposures or determine appropriate methods to transfer the risks. Step 3: Determine the collective effects of the risk exposures or perform a cost-benefit analysis on risk transfer methods. Step 4: Develop a risk mitigation strategy (i.e., avoid, transfer, mitigate, or assume risk). Step 5: Assess performance and amend risk mitigation strategy as needed. LO 1.3 Value at risk (VaR) states a certain loss amount and its probability of occurring.
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