LOS D requires us to:
explain how risk tolerance affects risk management
a. Risk tolerance is the level to which the entity is willing to experience the losses or opportunity costs and fail to meet its objectives.
b. The risk tolerance of a company defines its risk appetite.
c. There are two major sources of risk within an organization, the internal sources, and the external sources.
The internal factors are the shortfalls within the organization that would lead to its failure in achieving the critical goals, such as the lack of liquidity, lack of experience, etc.
The external factors, on the other hand, are the factors outside the organization such as environmental forces like foreign exchange, interest rates, etc.
d. Once the internal and external factors are identified, those dimensions of risk that the enterprise is unwilling to accept are defined.
e. The main factors that affect a higher risk tolerance are:
i. stronger competitive position,
ii. the loss that can be sustained for longer, and
iii. greater response agility, i.e. the speed, expertise, and flexibility with which the organization can respond to the risk-creating circumstances.
f. While defining the risk tolerance of a company, the management should ignore its personal motivation and beliefs.