HEBRON ACADEMY ENTREPRENEURSHIP CHALLENGE

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HEBRON ACADEMY ENTREPRENEURSHIP CHALLENGE

• RISK

Clement S. Dwyer, Jr. URSA Advisors, Inc. 1170 US
Highway 22 Bridgewater, NJ 08807
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RISK

• What is it?

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RISK is

• The possibility of suffering harm or loss from
  a hazard or other unforeseen or unanticipated
  event, happening or calamity!

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What are some RISKS?

• Fire, hurricane, earthquake

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• Automobile accident

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• Market loss or decline in value

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• Change in financial measure e.g. interest rate or
  credit worthiness
• Death or disability

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• Insolvency/bankruptcy

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• Betting
• Gambling
• Sky diving bungee jumping

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What do you do about RISKS?

• Ignore it, stay in bed pull the covers over your
  head!
• Dont engage in the activity.
• Take the Risk.
• Hope for the best, prepare for the worst.
• Manage or socialize the Risk.
• Transfer the Risk (another form of socialization).

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Ignore Risks

• Very human tendency dont like to think about
  our death or disability
• Accidents happen to other people youthful
  infallibility.
• Things happen for a reason, God will provide.
• - God doesnt meet the business payroll
• - File tax returns

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Dont engage in the activity

• Dont drink and drive !
• Forget sky diving, bungee jumping, hang gliding,
  or rock climbing.

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• Dont get on a motorcycle.

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JUST DO IT take the Risk!

• Jump from the plane or bridge. Not too many
  people die each year in these sports.
• Just one roadie.
• I can swim twice as fast as you to the float in
  the lake.
• Put 10,000 on black
• OK- most of the time you attempt what is
  within your capability OR were you just shot in
  the ass with luck?

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Hope for the best, prepare for the worst.

• Take out a fixed rate mortgage rather than a
  variable rate.
• Save for a rainy day, contribute to your IRA
• Check the parachute a second time.
• Dont drink and drive!
• Never light a cigarette, but purchase health
  insurance.

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Manage the Risk

• Install a sprinkler system in the building to put
  out a fire.
• But a stock index fund to match the stock market
  performance.
• Change your business practice, no delivery
  drivers with prior accidents or arrests.
• Apply to more than one college.
• All involve some incremental expense, doing
  things differently.

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Transfer the Risk

• Purchase insurance
• Property liability
• Disability
• Life
• Purchase a put option on Exxon which entitles you
  to sell the stock at a fixed price (85) within a
  fixed time period.
• Do a swap of a variable interest rate for a fixed
  interest rate for a premium or higher fixed rate
  difference is the cost.

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Two types of Risks

• Specific
• Systemic

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Specific Risks

• A specific risk is that uncertainty which
  attaches to a particular circumstance or outcome.
  
• You die.
• Rain or shine on Graduation day.
• Hebron beats Kents Hill in baseball tomorrow
• These outcomes are polar opposites - yes or
  no. They are called binary, like a light switch.

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Systemic Risks

• Systemic risk is the uncertainty that a
  particular outcome will result where there are a
  group of variables.
• The IDJN goes to 15,000
• A Force 5 hurricane hits Miami, Florida.
• An airplane crash lands in fog at Logan Airport.

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Systemic Risks (cont.)

• Allstate makes 1 billion profit in writing
  automobile insurance in the USA.
• The space shuttle Challenger disintegrates.

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• The Verona Island suspension bridge in Bucksport
  collapses on a windy day when the Backsport Band
  marches to Fort Knox.
• The Red Sox, Celtics, and Braves all win World
  Championships.

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Specific and Systemic Risks are driven by

• Probabilities
• What are the odds
• that something will happen?

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The Odds on Virtually Everything
By Richard M. Scammon
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Probability

• Is a numeric expression of an event or
  occurrence happening.
• Role of the Dice

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Probability Distribution
50
40
30
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Tail
10
0
100
200
This simulation shows you the shape of the curve
plotting the distribution of outcomes.
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Why do you care what the PROBABILITY DISTRIBUTION
looks like?

• It tells you the possible number and size of
  the outlying events - the TAIL
• Beware of FAT TAILS!
• These are infrequent, severe events, sometimes
  called catastrophes.

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Examples of FAT TAILS

• Plane crash

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• Terrorist attack

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Conditional Probabilities

• Frequently, catastrophic events are the
  product of multiple low probability events coming
  together. This is referred to as conditional
  probabilities.
• 10 chance of a 10 loss 1 chance of loss

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Why take Risk?

• For the personal or financial reward!

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Are you Risk adverse?

• What makes you Risk adverse?
• Do you get a thrill from betting, gambling or
  skydiving?

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• Every one has their own utility curve for
  taking Risk!!

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Utility Curve

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

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Lets discuss Utility Curves

• Betting
• Lottery tickets
• Cutting class
• Purchasing stocks
• Purchasing Series E US Government Bonds
• Investing your life savings in a business which
  you start up and own 100

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Lets discuss Utility Curves (cont.)

• Drinking and Driving
• Committing a crime
• Buying all the combinations to win the lottery
• Not buying health insurance
• Contribute 2000 to a Roth IRA

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• The Utility Curves we each have shape our
  choices in all decisions we make!
• 99.99 of the time, these odds come out about
  as expected.

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So what about 0.01 of the time?

• The Black Swan by Nassin Taleb
• Extreme event of extremely low probability
• Meteor striking the earth
• Dirty bomb attack in Portland, Maine
• Money becomes worthless
• Las Vegas, Nevada becomes a coastal city

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So what about 0.01 of the time?

• These are the things that get us, because we
  cannot comprehend them or the consequences.
• The really, really, FAT TAIL!
• Shit happens!

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Clems Six Rules of Personal Financial Risk
Management!

1. Dont be fooled by false precision when a
   reasonable approximation will do.
2. As Warren Buffet says, In a poker game, if you
   cant identify the mug, its you!
3. Always know the downside and quantify it.
4. Never place yourself or money at risk that you
   cannot afford to lose.
5. Your heart and emotions always cost you money.
6. Almost any reasonable plan will work, but you
   have to have a plan!

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WITHOUT RISK

• NO REWARD!