What is Event Risk?
Event Risk is the probability of an unexpected event that can negatively impact an organization, sector, or stocks. An event risk may arise out of any change in the market trends, which may affect the current state of the organization or the sector. Event risk can be any event or situation that has a possible impact on the smooth functioning of the organization. Organizations may opt to get insured against any event risks that are foreseen or unforeseen. Insurance companies provide insurance against a range of event risks that have a direct impact on the organization.
Types of Event Risk
Event Risk can arise out of various reasons, including unforeseen environmental or natural disasters, death of the CEO, failing to identify and utilize an opportunity, or events like fire or flood. These may be classified into four main categories based on the risk:
- Opportunity Risk
- Risk of uncertainty
- Risk of Hazards
- Operational Risk
Let’s take a look at each of these in detail.
#1 – Opportunity Risk
This is very similar to opportunity cost, but in this case, it is the risk that we are referring to. When an organization decides to engage their resources to a particular option, the organization stands a chance in either losing a better opportunity or failing to deliver or may even not generate the returns as expected during the inception of the option.
Opportunity Event Risk Example
Rick is looking for stocks to invest in the market but has limited funds and decides to invest in penny stocks. He considers investing in either of the stores of Zynga Inc or Amarin Plc. Looking at the previous trend and the sector in which both the business deal, Rick narrows down to invest in Amrain Plc. The market moved, and Zynga Inc, a social game developer, made a positive move whereas Amarin Plc fell further down from the point at which Rick had invested.
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An opportunity risk from Rick was investing in a stock of a company and expecting it to grow; however, out of the stores he had decided to invest, Zynga Inc performed better in the market. Still, Rick could not capitalize on the opportunity since he invested all of his resources on Amarin Plc.
#2 – Risk of Uncertainty
Just as the word suggests, these risks relate to the risk of uncertain events that can impact the smooth functioning of an organization. The risk of uncertainty arises from the luck of the circumstances that may intervene in the typical day to day activities. Moreover, these risks cannot be controlled due to its uncertainty; however, these can be insured against so that the damage is compensated for. Natural calamities, fire, market downfall, a decrease of market share due to new competitors in the market, legal actions, political unrest, which includes terrorist attacks, etc. are the best examples of the Risk of Uncertainty.
Steve Jobs, the co-founder, and CEO of Apple Inc., paved the pathway for Apple to reach the position it is at today. His ideology of innovation helped in creating the premium brand Apple. Major decisions like product launch and specification of products were all decided by Steve himself. In 2011, Steve succumbed to pancreatic cancer leaving behind a mammoth empire that he had created over the years. This is the risk of uncertainty of events that are unforeseen and can be a significant risk for an organization.
#3 – Risk of Hazards
Risk of hazards can refer to dangers that can arise out of improper handling or poor workplace design, resulting in dangerous events that result in severe damage to the people involved in the procedure. It may occur due to biological, psychological, chemical hazards, or improper allocation of duties depending on the skills.
The Chernobyl disaster of 1986 is one of the worst nuclear disasters that shook the world, which has lasting impacts. The event triggered due to the failure of skilled workers being present at the right time, which led to procedures being compromised.
#4 – Operational Risk
Operational risk is the risk that is involved in the day to day business activities. It may arise out of failed procedures, systems, or policies. It is one of the most dangerous risks since it can occur out of the activities or operations which are required for the functioning of the business.
Operational Event Risk Example
A trade for USD 10 million was agreed between two counterparties, Counterparty A and Counterparty B; however, when booking the trade-in system, the transaction was secured by Counterparty A as CAD 10 million. This would create a wrong Profit and Loss for the trader and would depict an incorrect position. At the time of settlement, there would be a significant incident related to the same since Counterparty B would be looking for USD, whereas Counterparty A will be paying in CAD. The operational activity of booking a trade onto the system was not done accurately, resulting in losses and rework, which eventually results in reputational and economic losses.
How is Understanding Event Risk Helpful?
- Studying the event risk involved in a business activity helps take appropriate measures to either curb the effects of the threat or eliminate the risk.
- Event risk helps in a better understanding of the risk and working towards enhancing the current procedures.
- An event risk refers to the risk which can cause reputational or economic damage to an organization or a sector.
- There are four significant classifications of event risk based on the risk: Opportunity Risk, Risk of Uncertainty, Risk of Hazards, and Operational Risk.
- Organizations and individuals can get insured against risks like natural calamities, fire, or other such unforeseen risks.
- Event Risks, if occur, can cause economic and reputational damage to the organization, which may eventually result in loss of business.
This has been a guide to what is Event Risk and its definition. Here we discuss each type of event risk along with examples and advantages. You can learn more about accounting from the following articles –