Unit 2: Risk Measurement and Metrics The previous unit explained how risk arises as a consequence of uncertainty and proposed that risk and uncertainty are connected but distinct concepts. This unit will discuss methods of measuring risk and uncertainty. In order to understand and use the concepts of risk and uncertainty, you need to be able to measure outcomes. All too often, assessments of risk are mere guesses, and the consequences can range from lost opportunities to death.
This unit will discuss measurable and quantifiable outcomes as well as how you can measure risk and uncertainty using numerical methods.
Unit 2 Time Advisory
This unit should take you approximately 9 hours to complete.
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Subunit 2.1: 4 hours
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Subunit 2.2: 5 hours
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Introduction: 3 hours
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Sub-subunit 2.2.2: 2 hours
Unit2 Learning Outcomes
Upon completion of this unit, the student will be able to:
- Use probability models to quantify the relative frequency of
occurrences of uncertain events.
- Identify and explain measures of frequency, severity, likelihood,
statistical distributions, and expected values.
- Compute common measures of risk using statistical concepts such as
probability and frequency.
2.1 Quantification of Uncertainty via Probability Models
- Reading: Risk Management for Enterprises and Individuals: “Chapter
2: Risk Measurement and Metrics:” “Section 2.1: Quantification of
Uncertainty via Probability Models”
Link: Risk Management for Enterprises and Individuals: “Chapter 2:
Risk Measurement and Metrics:” “Section 2.1: Quantification of
Uncertainty via Probability
Models”
(HTML)
Instructions: Please click on the link above, and read Section 2.1
in its entirety to learn how to use probability models. Remember to
complete the Discussion questions at the end of the reading. Make
sure that you understand the example illustrated in Table 2.3 before
continuing on to the next resource. Please note that this reading
also covers the information outlined in sub-subunits 2.1.1 through
2.1.4.
Reading, note-taking, and answering the Discussion questions should
take approximately 2 hours to complete.
Terms of Use: Please respect the copyright and terms of use
displayed on the webpage above.
- Assessment: Actuarial Science at Illinois State University: The
Society of Actuaries and the Casualty Actuarial Society’s “Practice
Exercises for Course P Examination”
Link: Actuarial Science at Illinois State University: The Society of
Actuaries and the Casualty Actuarial Society’s “Practice Exercises
for Course P
Examination”
(PDF)
Instructions: In this assessment, you will be asked to answer several questions on an actuarial exam. An actuary uses mathematics to quantify and to predict the financial impact of risk and uncertainty. In order to become an actuary, a person has to complete successfully a series of professional level exams. The practice exam that you will work is the basic exam, dealing with probability. To prepare for this assessment, you may want to refresh what you have learned from your Probability and Statistics courses.
To access the practice exam, click on the link above. Under the section titled Course P Examination: (Probability) click on the link “Practice Exercises for Course P Examination” to download the PDF file. This is a sample exam for Exam P of Society of Actuaries. The questions are on pages 1-82. For this course, please answer questions 6, 14, 29, 32, 33, 36, 48, 53, 64, and 99. After you complete this exam, check your answers against the solutions. You will notice that after the final question on page 82 the solutions are listed and the page numbers restart from 1-54.
This assignment will take you approximately 2 hours to complete.
Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.
2.1.1 Quantifying Uncertain Events Note: This topic is covered by the reading assigned below subunit 2.1. Focus on the text below the heading “Measurement Techniques for Frequency, Severity, and Probability Distribution Measures for Quantifying Uncertain Events.”
2.1.2 Measures of Outcome Value: Severity of Loss and Value of Gain Note: This topic is covered by the reading assigned below subunit 2.1. Focus on the text below the heading “Measures of Outcome Value: Severity of Loss and Value of Gain.”
2.1.3 Probability and Outcome Value: Assessment of an Uncertain Endeavor Note: This topic is covered by the reading assigned below subunit 2.1. Focus on the text below the heading “Combining Probability and Outcome Value Together to Get an Overall Assessment of the Impact of an Uncertain Endeavor.” Make sure that you understand the concept of “expected value,” which is critical in assessing the impact of an uncertain endeavor.
2.2 Measures of Risk: Putting It Together
- Reading: Risk Management for Enterprises and Individuals: “Chapter
2: Risk Measurement and Metrics:” “Section 2.2: Measures of Risk:
Putting It Together”
Link: Risk Management for Enterprises and Individuals: “Chapter 2:
Risk Measurement and Metrics:” “Section 2.2: Measures of Risk:
Putting It
Together”
(HTML)
Instructions: Please click on the link above, and read Section 2.2
in its entirety. Also, complete the Discussion questions at the end
of the reading. This reading discusses basic statistical concepts
that are used to measure risk, including Value at Risk (VaR),
Maximum Probable Annual Loss (MPAL), and Beta Measures. Note that
this reading also covers the topics outlined in sub-subunits 2.2.1
through 2.2.3.
Reading, note-taking, and answering the Discussion questions should
take approximately 2 hours to complete.
Terms of Use: Please respect the copyright and terms of use
displayed on the webpage above.
Assessment: McGraw-Hill: Bodie, Kane, and Marcus’s Investments, 9th edition: “Chapter 9 Multiple Choice Quiz” The Saylor Foundation does not yet have materials for this portion of the course. If you are interested in contributing your content to fill this gap or aware of a resource that could be used here, please submit it here.
2.2.1 Some Common Measures of Risk: Range and Deviation Note: This topic is covered by the reading assigned below subunit 2.2. Focus on the text below the heading “Some Common Measures of Risk: Range and Deviation.”
2.2.2 Financial Measures: Value at Risk (VaR) and Maximum Probable Annual Loss (MPAL) Note: This topic is covered by the reading assigned below subunit 2.2. Focus on the text below the heading “Financial Measures: Value at Risk (VaR) and Maximum Probable Annual Loss (MPAL).”
Reading: McKinsey & Company’s Working Papers on Risk, Number 32: Mehta et al.’s “Managing Market Risk: Today and Tomorrow” Link: McKinsey & Company's Working Papers on Risk, Number 32: Mehta et al.'s "Managing Market Risk: Today and Tomorrow"
Instructions: Please click on the link above to view a collection of McKinsey's latest topics on risk management. Then, select the article's title, "Managing Market Risk: Today and Tomorrow," to download the PDF file. Read the entire article. Value at Risk (VaR) has been the cornerstone of risk management at financial institutions for decades. This reading provides an in-depth discussion of the limitations of VaR and how these limitations are addressed in real time.
Studying this reading should take approximately 2 hours to complete.
Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.
2.2.3 CAPM’s Beta Measure of Nondiversifiable Portfolio Risk Note: This topic is covered by the reading assigned below subunit 2.2. Focus on the text below the heading “Capital Asset Pricing Model.”
Subunit 2.2 Assessment
- Assessment: The Saylor Foundation’s “Assessment for Subunit 2.2”
Link: The Saylor Foundation’s “Assessment for Subunit
2.2”
(PDF) and “Subunit 2.2 Answer
Key”
(PDF).
Instructions: Complete this assessment after you finish the
readings of Subunit 2.2. Write down your answers before checking
with the Answer Key.