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HEBRON ACADEMY HEBRON ACADEMY ENTREPRENEURSHIP ENTREPRENEURSHIP

CHALLENGECHALLENGE

““RISK”RISK”Clement S. Dwyer, Jr.

URSA Advisors, Inc.

1170 US Highway 22

Bridgewater, NJ 08807

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RISK…RISK…What is it?What is it?

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RISK isRISK is

The The possibilitypossibility of suffering harm of suffering harm

or loss from a hazard or other or loss from a hazard or other

unforeseen or unanticipated unforeseen or unanticipated

event, happening or calamity!event, happening or calamity!

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What are some RISKS?What are some RISKS?

Fire, hurricane, earthquakeFire, hurricane, earthquake

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Automobile accidentAutomobile accident

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Market loss or decline in valueMarket loss or decline in value

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Change in financial measure e.g. Change in financial measure e.g. interest rate or credit worthinessinterest rate or credit worthiness

Death or disabilityDeath or disability

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Insolvency/bankruptcyInsolvency/bankruptcy

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BettingBetting GamblingGambling Sky diving – bungee jumpingSky diving – bungee jumping

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What do you do about RISKS?What do you do about RISKS?

Ignore it, stay in bed –pull the covers Ignore it, stay in bed –pull the covers over your head!over your head!

Don’t engage in the activity.Don’t engage in the activity. Take the Risk.Take the Risk. Hope for the best, prepare for the Hope for the best, prepare for the

worst.worst. Manage or socialize the Risk.Manage or socialize the Risk. Transfer the Risk (another form of Transfer the Risk (another form of

socialization).socialization).

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Ignore RisksIgnore Risks

Very human tendency; don’t like to Very human tendency; don’t like to think about our death or disabilitythink about our death or disability

Accidents happen to other people; Accidents happen to other people; youthful infallibility.youthful infallibility.

Things happen for a reason, God will Things happen for a reason, God will provide.provide.

- God doesn’t meet the business - God doesn’t meet the business payrollpayroll - File tax returns- File tax returns

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Don’t engage in the activityDon’t engage in the activity

Don’t drink and drive !Don’t drink and drive ! Forget sky diving, bungee jumping, Forget sky diving, bungee jumping,

hang gliding, or rock climbing.hang gliding, or rock climbing.

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Don’t get on a motorcycle.Don’t get on a motorcycle.

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JUST DO IT – take the Risk!JUST DO IT – take the Risk!

Jump from the plane or bridge. Not too Jump from the plane or bridge. Not too many people die each year in these sports.many people die each year in these sports.

Just one “roadie’.Just one “roadie’. I can swim twice as fast as you to the float I can swim twice as fast as you to the float

in the lake.in the lake. Put $10,000 on blackPut $10,000 on black OK- most of the time you attempt what is OK- most of the time you attempt what is

within your capability OR within your capability OR were you just were you just shot in the ass with luck?shot in the ass with luck?

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Hope for the best, Hope for the best, prepare for the worst.prepare for the worst.

Take out a fixed rate mortgage Take out a fixed rate mortgage rather than a variable rate.rather than a variable rate.

Save for a rainy day, contribute to Save for a rainy day, contribute to your IRAyour IRA

Check the parachute a second time.Check the parachute a second time. Don’t drink and drive!Don’t drink and drive! Never light a cigarette, but purchase Never light a cigarette, but purchase

health insurance.health insurance.

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Manage the RiskManage the Risk

Install a sprinkler system in the building to Install a sprinkler system in the building to put out a fire.put out a fire.

But a stock index fund to match the stock But a stock index fund to match the stock market performance.market performance.

Change your business practice, no delivery Change your business practice, no delivery drivers with prior accidents or arrests.drivers with prior accidents or arrests.

Apply to more than one college.Apply to more than one college. All involve some incremental expense, All involve some incremental expense,

doing things differently.doing things differently.

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Transfer the RiskTransfer the Risk Purchase insurancePurchase insurance

– Property liabilityProperty liability– DisabilityDisability– LifeLife

Purchase a put option on Exxon which Purchase a put option on Exxon which entitles you to sell the stock at a fixed entitles you to sell the stock at a fixed price (85) within a fixed time period.price (85) within a fixed time period.

Do a swap of a variable interest rate for a Do a swap of a variable interest rate for a fixed interest rate for a premium or higher fixed interest rate for a premium or higher fixed rate; difference is the cost.fixed rate; difference is the cost.

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Two types of Two types of RisksRisks

SpecificSpecificSystemicSystemic

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Specific Specific RisksRisks

A specific risk is that uncertainty which A specific risk is that uncertainty which attaches to a particular circumstance or attaches to a particular circumstance or outcome. outcome.

You die.You die. Rain or shine on Graduation day.Rain or shine on Graduation day. Hebron beats Kents Hill in baseball Hebron beats Kents Hill in baseball

tomorrowtomorrow These outcomes are polar opposites - yes These outcomes are polar opposites - yes

or no. They are called binary, like a light or no. They are called binary, like a light switch. switch.

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Systemic Systemic RisksRisks

Systemic risk is the uncertainty that Systemic risk is the uncertainty that a particular outcome will result a particular outcome will result where there are a group of variables.where there are a group of variables.

The IDJN goes to 15,000The IDJN goes to 15,000 A Force 5 hurricane hits Miami, A Force 5 hurricane hits Miami,

Florida.Florida. An airplane crash lands in fog at An airplane crash lands in fog at

Logan Airport.Logan Airport.

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Systemic Systemic RisksRisks (cont.) (cont.)

Allstate makes $1 billion profit in Allstate makes $1 billion profit in writing automobile insurance in the writing automobile insurance in the USA.USA.

The space shuttle Challenger The space shuttle Challenger disintegrates.disintegrates.

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The Verona Island suspension bridge The Verona Island suspension bridge in Bucksport collapses on a windy in Bucksport collapses on a windy day when the Backsport Band day when the Backsport Band marches to Fort Knox.marches to Fort Knox.

The Red Sox, Celtics, and Braves all The Red Sox, Celtics, and Braves all win World Championships. win World Championships.

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Specific and Systemic Risks are Specific and Systemic Risks are driven by …driven by …

Probabilities Probabilities What are the odds What are the odds

that something will happen? that something will happen?

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The Odds The Odds onon

Virtually Everything Virtually Everything

By Richard M. Scammon

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Probability:Probability:

Is a numeric expression of an event Is a numeric expression of an event or occurrence happening.or occurrence happening.

Role of the DiceRole of the Dice

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Probability DistributionProbability Distribution

This simulation shows you the shape of the curve plotting the distribution of outcomes.

0 100 200

10

20

30

40

50

Tail

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Why do you care what the Why do you care what the PROBABILITY DISTRIBUTION PROBABILITY DISTRIBUTION

looks like? looks like?

It tells you the possible number and size of It tells you the possible number and size of the outlying events - the “TAIL”the outlying events - the “TAIL”

BewareBeware of of FAT TAILS!FAT TAILS!

These are infrequent, severe events, These are infrequent, severe events, sometimes called catastrophes.sometimes called catastrophes.

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Examples of Examples of FAT TAILSFAT TAILS

Plane crashPlane crash

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Terrorist attackTerrorist attack

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Conditional ProbabilitiesConditional Probabilities

Frequently, catastrophic events are Frequently, catastrophic events are the product of multiple low the product of multiple low probability events coming together. probability events coming together. This is referred to as conditional This is referred to as conditional probabilities. probabilities.

10% chance of a 10% loss = 1% 10% chance of a 10% loss = 1% chance of losschance of loss

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Why take Risk? Why take Risk?

For the personal or For the personal or financial reward! financial reward!

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Are you Risk adverse?Are you Risk adverse?

What makes you Risk adverse? What makes you Risk adverse? Do you get a thrill from betting, Do you get a thrill from betting,

gambling or skydiving? gambling or skydiving?

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Every one has their own “Every one has their own “utility utility curvecurve” for taking Risk!!” for taking Risk!!

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Utility CurveUtility Curve

The “The “utility curveutility curve” is what you ” is what you are willing to lose for a given are willing to lose for a given reward based on your perception reward based on your perception or analysis of the chances of or analysis of the chances of success (or failure).success (or failure).

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Let’s discuss “Let’s discuss “Utility CurvesUtility Curves””

Betting Betting Lottery ticketsLottery tickets Cutting classCutting class Purchasing stocksPurchasing stocks Purchasing Series E US Government Purchasing Series E US Government

BondsBonds Investing your life savings in a Investing your life savings in a

business which you start up and own business which you start up and own 100%100%

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Let’s discuss “Let’s discuss “Utility CurvesUtility Curves” (cont.)” (cont.)

Drinking and DrivingDrinking and Driving Committing a crimeCommitting a crime Buying all the combinations to win Buying all the combinations to win

the lotterythe lottery Not buying health insuranceNot buying health insurance Contribute $2000 to a Roth IRAContribute $2000 to a Roth IRA

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The “The “Utility CurvesUtility Curves” we ” we each have shape our each have shape our choices in all decisions choices in all decisions we make!we make!

99.99% of the time, these 99.99% of the time, these odds come out about as odds come out about as expected. expected.

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So what about 0.01% of the time?So what about 0.01% of the time?

“ “ The Black Swan” by Nassin TalebThe Black Swan” by Nassin Taleb

Extreme event of extremely low probabilityExtreme event of extremely low probability Meteor striking the earthMeteor striking the earth Dirty bomb attack in Portland, MaineDirty bomb attack in Portland, Maine Money becomes worthlessMoney becomes worthless Las Vegas, Nevada becomes a coastal cityLas Vegas, Nevada becomes a coastal city

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So what about 0.01% of the time?So what about 0.01% of the time?

These are the things that get us, These are the things that get us, because we cannot comprehend because we cannot comprehend them or the consequences. them or the consequences.

The really, really, The really, really, FAT TAILFAT TAIL! !

““Shit happens!” Shit happens!”

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Clem’s Six Rules of Personal & Clem’s Six Rules of Personal & Financial Risk Management!Financial Risk Management!

1.1. Don’t be fooled by false precision when a Don’t be fooled by false precision when a reasonable approximation will do.reasonable approximation will do.

2.2. As Warren Buffet says, “In a poker game, if you As Warren Buffet says, “In a poker game, if you can’t identify the mug, it’s you!”can’t identify the mug, it’s you!”

3.3. Always know the downside and quantify it.Always know the downside and quantify it.4.4. Never place yourself or money at risk that you Never place yourself or money at risk that you

cannot afford to lose.cannot afford to lose.5.5. Your heart and emotions always cost you Your heart and emotions always cost you

money.money.6.6. Almost any reasonable plan will work, but you Almost any reasonable plan will work, but you

have to have a plan!have to have a plan!

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WITHOUT RISK…WITHOUT RISK…

NO REWARD! NO REWARD!