ERM Flashcards — Part 2 FINAL

Components of ERM

Final versions: [Pt.1] [Pt.2] [Pt.3] [Pt.4] [Pt.5] [Pt.6]

• [08] Structural changes to operations that can lead to more flexibility (4): 1. increase outsourcing; 2. spread operations to other sites/countries (reduce concentration); 3. shift distribution channels (physical store to online); 4. move to multi-disciplinary project teams
• [08] Actuarial control cycle (5): general commercial and economic environment >>; (specify problem <-> develop solution <-> monitor experience); << professionalism
• [08] Sweeting’s ERM cycle (5): Identification >> Assessment >> Management >> Monitoring >> Modification >> Identification
• [08] Three lines of defense: 1. line management staff in business units; 2. CRO, risk management team and compliance team; 3. Board and audit function
• [08] Responsibilities of first line of defense: Measure and manage risk in individual business units on a daily basis (in line with company’s risk appetite and risk policies)
• [08] Responsibilities of second line of defense (3): 1. establish risk and compliance policies; 2. support and monitor line management; 3. report to Board
• [08] Responsibilities of third line of defense: Effective governance of risk management process (set strategy, approve policies, ensure effectiveness)
• [09] Risk profile: Complete description of current and emerging risks faced by a company
• [09] Risk capacity: Upper bound for risk exposures determined by regulators, legislative limits, availability of capital and/or other stakeholders
• [09] Items requiring clear statements in RM policies (5): 1. upper bound for risk exposure; 2. current risk exposure; 3. desired risk exposure; 4. breakdown of upper bound and risk targets into more detailed statements; 5. detailed operational guidelines for managers
• [09] Utility function: Measure of happiness or satisfaction as a function of wealth, can express different attitudes to potential gains and losses
• [09] Features of realistic utility functions (2): 1. monotonic increasing (having more of something is always better); 2. concave (marginal utility decreases as wealth increases)
• [09] Common utility functions (3): 1. quadratic; 2. exponential; 3. power
• [09] Features of quadratic utility functions (2): 1. can use to maximize expected wealth subject to volatility; 2. increasing absolute and relative risk aversion
• [09] Features of exponential utility functions (2): 1. constant absolute risk aversion; 2. increasing relative risk aversion
• [09] Features of power utility functions (2): 1. decreasing absolute risk aversion; 2. constant relative risk aversion
• [09] Shape of prospect function: S-shaped, function is concave above W_0 and convex below W_0
• [09] Reasons why prospect functions are better than utility functions (2): 1. considers investor’s starting point of wealth (risk seeking when facing losses, risk averse when facing gains); 2. prospect function flattens out at both ends (reflects ambivalence to gains/losses at extremes of wealth)
• [09] Time period covered by risk management policy: Generally similar to what is in the company’s business plans (3 to 5 years), reviewed at least annually
• [09] Contents of RM policy — objectives and definitions (3): 1. goals of ERM activities; 2. statement of company’s philosophy on risk management and desired risk culture; 3. risk categories and definitions (taxonomy)
• [09] Contents of RM policy — risk management structure (2): 1. role of risk managers (CEO, CRO, executive managers, risk sponsors, risk owners, risk committee members); 2. structure of corporate governance (delineation of responsibilities)
• [09] Contents of RM policy — processes and benchmarks (3): 1. overview of each stage of risk management process; 2. risk appetite and tolerance statements; 3. risk policy standards (ensure risk policies are consistent across company)
• [09] Risk appetite: Degree of risk that an organization is willing to accept in order to achieve its objectives
• [09] Possible standards used in probabilistic risk appetite statements (5): 1. solvency level; 2. target credit rating; 3. earnings volatility; 4. ability to pay dividends; 5. economic capital
• [10] Key RM processes requiring documentation (5): 1. risk identification and assessment; 2. decisions made and their reasons; 3. systems (specs, UAT); 4. financial models (data, assumptions); 5. failures
• [10] Desirable features of data used for monitoring (4): 1. timely; 2. reliable; 3. relevant; 4. balance of quantity and clarity
• [10] Types of communication (5): 1. internal; 2. external (inwards); 3. external (outwards); 4. informal; 5. formal
• [10] Development process for risk metrics (3): 1. Board sets a limit on level of risk that is acceptable; 2. RMF conducts analysis to identify key drivers that may lead to breaching the limit; 3. RMF sets up risk metrics to monitor these drivers to get an early indication of changes in risk profile
• [10] Considerations for selecting KRIs (5): 1. polices and regulations; 2. strategies and objectives; 3. past losses and incidents; 4. stakeholder requirements; 5. risk assessments
• [10] Desirable features of KRIs (12): 1. based on consistent methods and standards; 2. incorporate key risk drivers; 3. quantifiable; 4. tracked over time; 5. tied to objectives; 6. linked to an accountable individual; 7. useful in decision making; 8. able to be benchmarked externally; 9. timely; 10. cost effective to measure; 11. simple (not simplistic); 12. both leading and lagging indicators
• [10] Components of a risk report to the Board (6): 1. qualitative and quantitative information; 2. summary of losses and incidents; 3. summary of business risks and key discussions and decisions required of the Board; 4. narrative from management on important data and trends; 5. KPIs against KRIs with important deviations and trends highlighted; 6. important events and milestones (regulatory visit)
• [10] Design features of a management reporting system (2): 1. use a top-down approach (consider what information is necessary to make management decisions then identify and source this information); 2. data is presented in an easily understandable way
• [10] Desirable features of a management reporting system (9): 1. clear; 2. relevant; 3. timely; 4. reliable; 5. single point of access to critical information collected from various data sources; 6. role-based summary with drill-down capabilities; 7. link to decisions that need to be made; 8. mix of qualitative/quantitative and internal/external data; 9. opportunity for users to provide commentary
• [10] Common mistakes of management reporting systems (4): 1. simply collating data from silos; 2. overwhelming users with too much information; 3. providing data that does not aid decision making; 4. focus on quantity instead of quality of information
• [10] Considerations in an ERM scorecard (4): 1. cost of risk and mitigation strategies; 2. regulatory or policy violations; 3. performance based feedback loops (actual versus expected); 4. ERM development milestones
• [11] Categories of stakeholders (5): 1. principal (contribute capital and/or expect returns); 2. agency (paid by principals to perform specific roles); 3. controlling (supervise principals or their agents); 4. advisory (advise principals or their agents); 5. incidental (affected by the behaviors and actions of principals or their agents)
• [11] Role of proxy advisers (2): Also called shareholder service providers (ISS-US and PIRC-UK), on behalf of shareholders; 1. express views on the company; 2. manage proxy voting
• [11] Concerns about the role of proxy advisers (3): 1. power but no responsibility; 2. potential for conflict of interest (may also consult for company); 3. tick-box method (template applied to all firms)
• [11] Key aspects of customer management (4): 1. acquisition; 2. retention; 3. knowing the customer; 4. effective crisis management
• [11] Features of effective crisis management (5): 1. be honest, don’t cover up; 2. act swiftly to resolve; 3. keep stakeholders informed; 4. focus on long term value instead of short term costs; (5. have a contingency plan before crisis occurs)
• [11] Types of employees with high agency risk (3): 1. employees lower in the org chart; 2. members of unions; 3. free agents (people who are self employed or who could be if they wished)
• [11] Key aspects of employee management (3): 1. recruitment; 2. retention, promotion, training; 3. dismissal and resignations
• [11] Post-2008 regulatory changes (5): 1. updated SEC disclosure requirements; 2. temporary bans on short-selling; 3. Dodd-Frank Act (new regulators, orderly liquidation plan for banks); 4. replacement of FSA with PRA and FCA in the UK; 5. greater likelihood that regulatory capital requirements exceed capital determined from internal models
• [11] Key risks faced by governments (4): 1. insufficient tax revenues; 2. inappropriate insolvencies; 3. regulatory arbitrage; 4. electoral losses
• [11] Key risks faced by professional advisers (3): 1. reputational risk; 2. litigation risk; 3. conflict of interest
• [11] Key risks faced by rating agencies (2): 1. reputational risk; 2. conflict of interest
• [11] Potential benefits of a strategic alliance (4): 1. faster product development; 2. access to new markets; 3. sharing of financial risks; 4. economies of scale
• [11] Potential pitfalls of a strategic alliance (4): 1. conflicts of interest; 2. waste of resources; 3. damage to reputation; 4. loss of intellectual capital and disputes over intellectual property
• [11] Strategies to maximize benefits of a strategic alliance (3): 1. only form alliance if it really is the best option (best meets specific goal, full merger is not needed); 2. find the right alliance partner (team should evaluate potential partners); 3. monitor progress of alliance carefully (adequate resources, regular refocusing)
• [11] Benefits of separating management and ownership (3): 1. enables people with expertise in running a business to make decisions without requiring them to invest capital; 2. allows individuals and companies to invest without getting involved in the day-to-day running of the company; 3. continuity of management despite frequent change in owners
• [11] Role of agency risk in 2008 crash: Short term nature of employee reward structures led to misalignment of interests. (some employees were given bonuses based on growth in total amount loaned)
• [11] Key stakeholders (9): 1. directors; 2. shareholders; 3. employees; 4. customers or policyholders; 5. government and regulators; 6. auditors; 7. credit rating agencies; 8. shareholder service providers; 9. business partners
• [11] Issues arising from stakeholder conflicts (6): 1. agency risk; 2. different objectives of debt holders and equity holders; 3. dominant CEO and employees who try to win favor; 4. managers wanting to protect job security by making low-risk decisions; 5. regulators whose prospects are enhanced by financial crisis; 6. governments who favor short term approaches to seek re-election
• [12] CRO position in an org chart: Sit on Board or report to Board through CEO or CFO
• [12] Key responsibilities of the CRO (8): 1. manage various risk functions; 2. provide leadership and direction; 3. design and implement ERM framework; 4. ongoing risk policy development; 5. risk reporting (internal and external); 6. capital allocation; 7. stakeholder communication on risk profile; 8. develop systems to analyze, monitor and manage risk
• [12] Key skills of a CRO (6): 1. leadership (have vision, recruit); 2. communication; 3. stewardship (guardian of assets); 4. technical competence; 5. consulting (influence and educate Board); project and change management
• [12] Items a new CRO needs to assess (9): 1. understanding of company’s risk tolerance; 2. management compensation alignment; 3. risk reporting channels; 4. gaps in skills, capability and experience of team; 5. which business units increase overall value; 6. link between risk management and capital management, pricing and reserving; 7. quality and extent of stakeholder communication; 8. governance structures; 9. appropriateness of risk management operating model
• [12] New CRO endeavors (3): 1. establish close working relationship with CFO; 2. authority within the organization; 3. understand key stakeholders and drivers of performance
• [12] Responsibilities of the CRF (7): 1. give advice to Board on risk; 2. assess overall risks; 3. compare overall risks with risk appetite; 4. act as central focus point for staff to report new and enhanced risks; 5. give guidance to line managers about identification and management of risks; 6. monitor risk management progress; 7. put whole picture together
• [12] Types of relationships between the first two lines of defense (3): 1. offense versus defense; 2. policy and policing; 3. partnership
• [12] Offense versus defense relationship: Business units focus on maximizing income and risk management focuses on minimizing loss
• [12] Problem with offense versus defense relationship: Potentially destructive and damaging to company as business units and risk management function have opposing objectives and incentives
• [12] Policy and policing relationship: Business units operate within rules set by the risk management function and policed by the risk management, audit and compliance functions
• [12] Problems with policy and policing relationship (4): 1. policies may become out of date (RMF not in touch with day-to-day operations); 2. audit and compliance reviews are not continuous (can miss things); 3. friction between line management and risk management; 4. line management has little incentive to report problems and violations
• [12] Partnership relationship between first two lines of defense: Risk management staff are integrated into the business units and the two functions share some measures of performance
• [12] Problem with partnership relationship between first two lines of defense: Independence may suffer, hard for risk management staff integrated into business units to also have a corporate oversight role
• [12] Mixed approach between first two lines of defense: In a large company, the risk management function can be split between a central team and units embedded in each business unit (need to ensure a silo mentality does not develop, can use a matrix reporting framework)
• [12] Methods to address inaccuracies in assumptions (2): 1. set trigger points; 2. set up specific risk committee
• [12] Best practices for remuneration in financial organizations (3): 1. link between executive compensation and risk management should be disclosed (salaries and bonuses); 2. compensation arrangements should not encourage excessive or inappropriate risk taking; 3. clawback provisions should be implemented where appropriate and practical
• [12] Responsibilities of the internal audit function (6): 1. monitor compliance with laws and regulations; 2. look for non-observance of internal governance codes; 3. ensure company systems are secure; 4. check for system errors; 5. examine key financial calculations; 6. examine key procedures
• [12] Assurance systems: Processes and structures designed to give the Board confidence that the ERM framework is effective
• [13] Process for risk identification and assessment (6): 1. business analysis; 2. identify risks; 3. obtain agreement (on risks and responsible individuals); 4. evaluate risks; 5. produce risk register; 6. review register regularly
• [13] Components of business analysis (7): 1. business plan; 2. company structure and internal controls; 3. current and projected accounts and accounting ratios; 4. market information; 5. resources available; 6. legislative and regulatory constraints; 7. general economic environment
• [13] Conditions for benefiting from risk identification and assessment (5): 1. senior sponsorship; 2. consistent standards used over time; 3. comprehensive risk profile (quantitative and qualitative); 4. integrated with rest of risk management process; 5. demonstrate added value
• [13] Lam’s process for ensuring value add from risk identification and assessment (4): 1. foundation setting; 2. risk identification, assessment and prioritization; 3. deep dives, risk quantification and management; 4. business and ERM integration
• [13] Steps in Lam’s foundation setting (5): 1. gain executive sponsorship; 2. organize and plan resources; 3. define risk taxonomy; 4. build customized risk identification and assessment tools; 5. educate and train project teams and management
• [13] Steps in Lam’s risk identification, assessment and prioritization (4): 1. understand business objectives, risk appetite, and regulatory requirements; 2. undertake risk assessments (top-down and bottom-up); 3. produce risk reports and risk maps; 4. prioritize risks
• [13] Steps in Lam’s deep dives, risk quantification and management (3): 1. conduct more detailed assessments of top risks; 2. produce risk tolerance statements and track KRIs; 3. determine risk management strategies and total cost of risk
• [13] Steps in Lam’s business and ERM integration (6): 1. link risk assessment with strategic planning and business review; 2. integrate risk assessment into everyday operations; 3. conduct scenario analysis and stress testing; 4. report on risks; 5. create and maintain loss event database; 6. establish risk escalation policies
• [13] Pitfalls in foundation setting (3): 1. lack of senior management buy-in and participation; 2. bad resource planning and allocation; 3. insufficient preparation leading to inefficient or ineffective process
• [13] Pitfalls in risk identification, assessment and prioritization (3): 1. lack of clear business objectives or risk appetite; 2. focus on consequences instead of causes of risk; 3. inconsistent estimates of likelihood and severity
• [13] Pitfalls in deep dives, risk quantification and management (3): 1. lack of prioritization of key risks; 2. insufficient risk quantification; 3. risk assessment not translated into value adding actions
• [13] Pitfalls in business and ERM integration (2): 1. restricting integration to low level reports; 2. failure to fundamentally change business attitude to risk management
• [13] Tools used in risk identification (6): 1. SWOT analysis; 2. risk checklist; 3. risk prompt list; 4. risk taxonomy; 5. case studies; 6. process analysis
• [13] Risk checklist: List of risks identified on past projects or from external source
• [13] Risk prompt list: List of different categories of risks to consider with examples of each, i.e. PEST(ELI) covers Political, Economic, Social, Technological (Environmental, Legal, Industry)
• [13] Risk taxonomy: Structured way to classify and break down risks
• [13] Process analysis: Construct flow charts that detail business processes and the links between them
• [13] Common pitfall in risk identification: Not comprehensive (due to bias in the process or participants)
• [13] Techniques used in risk identification (7): 1. brainstorming; 2. independent group analysis; 3. surveys; 4. gap analysis; 5. Delphi technique; 6. interviews; 7. working groups
• [13] Brainstorming: Gather a group of people and generate ideas in a free form way, often facilitated by an external consultant and requires participants to be in the same location at the same time
• [13] Independent group analysis: Each risk is presented and then discussed by the group, an agreed list of risks is ranked independently by each member, and responses are combined to form an overall ranking
• [13] Benefits of using surveys: Online or postal surveys can generate a wide range of responses cheaply and without collusion between participants
• [13] Gap analysis: Questionnaire designed to identify current risk exposures (best done by line management) and desired (best done by Board)
• [13] Delphi technique: Structured communication technique where participants answer questionnaires in two or more rounds. After each round, a facilitator provides an anonymous summary of the previous round conclusions and reasons. Participants then revise their earlier answers and range of answers will hopefully converge to a consensus.
• [13] Benefits of the Delphi technique (2): 1. maintain anonymity and independence; 2. address difficulties in designing questionnaires and surveys
• [13] Working groups: Small number of individuals (usually specialists) are tasked with considering specific risks
• [13] Pitfalls of brainstorming (2): 1. convergent thinking (group think); 2. uneven participation leads to incomplete or biased results
• [13] Pitfalls of independent group analysis: Unbalanced groups may produce biased results
• [13] Pitfalls of surveys (2): 1. poor response rate; 2. framing issues (question asked influences response)
• [13] Disadvantages of gap analysis: Difficult or costly to engage Board
• [13] Disadvantages of Delphi technique: Time consuming and costly
• [13] Disadvantages of interviews (2): 1. time consuming and costly; 2. multiple interviewers can lead to inconsistencies
• [13] Pitfalls of working groups: If members are specialists, identification will be more narrow and specialists may want to work at a higher level of precision than is cost justified
• [13] Key elements of a risk register (7): 1. labeling or numbering system for risks identified; 2. category of risk; 3. clear description of risk; 4. assessment of likelihood and applicable timeframe; 5. response action, cost and expected residual risks; 6. individuals involved; 7. version control
• [13] Risk concepts discussed in Lam (7): 1. exposure; 2. volatility; 3. probability; 4. severity; 5. time horizon; 6. correlation; 7. capital
• [13] Reasons to hold capital (3): 1. manage cashflow (working capital); 2. facilitate growth and new ventures (development capital); 3. cover unexpected losses (risk capital)
• [13] Benefits of risk mapping (3): 1. gets people together to talk about risks; 2. improves understanding of risks, effects of risk management activities, and which risks require further attention; 3. final result is an excellent visual tool for reporting to Board
• [13] Reasons why emerging risks are important (3): 1. influence corporate strategy; 2. may affect profits; 3. may yield opportunities
• [13] Trends leading to emerging risk challenges (4): 1. globalization; 2. technology; 3. changing market structures (deregulation, privatization); 4. restructuring (M&A, outsourcing)
• [13] Emerging IT risks (3): 1. cyber security; 2. cloud computing; 3. social media
• [13] Cyber risk: Any risk of financial loss, disruption or damage to the reputation of an organization from some sort of failure of its IT systems
• [13] Horizon scanning: Systematic search for potential developments over the long term, with emphasis on changes that are at the edges of current thinking
• [13] Types of behavioral bias (3): 1. overconfidence; 2. anchoring; 3. representative heuristics (what is easier to imagine is deemed more likely)
• [13] Ways to reduce the problem of bias (2): 1. incorporate checks and balances; 2. introduce optimism bias
• [14] Risk measure: Function indicating the amount of capital that should be added to a risk portfolio with loss distribution L to make it acceptable to the risk controller
• [14] Axioms of coherence (4): 1. monotonicity; 2. subadditivity; 3. positive homogeneity; 4. translation invariance
• [14] Monotonicity: L1≤L2 then F1≤F2; If portfolio 2 exhibits greater losses under all future scenarios than portfolio 1, then risk will be higher for portfolio 2
• [14] Subadditivity: F(L1+L2)≤F(L1)+F(L2); Merging risk situations does not increase overall level of risk
• [14] Positive homogeneity: F(k*L)=k*F(L) for any constant k≥0; Doubling the size of loss will double the risk
• [14] Translation invariance: F(L+k)=F(L)+k for any constant k≥0; Adding or deducting an amount from the loss means that the capital needed to mitigate the impact is changed by the same amount
• [14] Convex risk measure: F(w*L1 +(1-w)*L2)≤w*F(L1)+(1-w)*F(L2); Diversification can reduce risk and amount of risk capital needed
• [14] Benefits of deterministic versus probabilistic measures: Deterministic measures are simplistic, giving a board indication of the level of risk; Probabilistic measures are potentially more accurate, but are more complex and can imply inappropriate levels of confidence
• [14] Deterministic risk measures (3): 1. notional; 2. factor sensitivity; 3. scenario sensitivity
• [14] Notional approach to risk measures: Broad-rush risk measure, e.g. risk weightings can be applied to market value of assets and total can be compared to liabilities to determine notional risk-adjusted financial position
• [14] Advantage of notional approach to risk measures: Simple to implement and interpret across a diverse range of companies
• [14] Disadvantages of notional approach to risk measures (5): 1. potentially undesirable use of a catch-all weighting for undefined asset classes; 2. possible distortions in the market caused by increased demand for asset classes with high weightings; 3. treating short positions as exact opposites of long positions; 4. no allowance for risk concentration; 5. probability of changes in asset and liability values are not quantified
• [14] Factor sensitivity approach to risk measures: Determines degree to which a company’s financial position is affected by the impact of a change in a single underlying risk factor
• [14] Advantage of sensitivity approach to risk measures: Increased understanding of risk drivers
• [14] Disadvantages of sensitivity approach to risk measures (3): 1. not assessing wider range of risks; 2. difficult to aggregate over multiple risk factors; 3. probability of changes considered is not quantified
• [14] Scenario sensitivity approach to risk measures: Similar to factor sensitivity, but considers the effect of changing a set of risk factors
• [14] Probabilistic risk measures (5): 1. deviation (including volatility); 2. Value at Risk; 3. probability of ruin; 4. Tail Value at Risk (or conditional value at risk); 5. expected shortfall
• [14] Information ratio: Average excess (active) return over tracking error
• [14] Advantages of deviation measures (3): 1. simple to calculate; 2. applicable to wide range of risks; 3. can be aggregated if correlations are known
• [14] Disadvantages of deviation measures (4): 1. difficult to interpret comparisons (other than simple ranking); 2. misleading if underlying distribution is skewed; 3. does not focus on tail risk and underestimates tail if leptokurtic; 4. aggregation can be misleading if components are not normally distributed
• [14] Basel VaR requirements: 99% confidence level over 10-day horizon
• [14] Advantages of VaR (4): 1. simple expression; 2. units mean something; 3. applicable to all risk types and risk sources; 4. easily translates into a risk limit
• [14] Disadvantages of VaR (5): 1. no indication on losses greater than VaR; 2. can underestimate asymmetric and fat-tailed risks; 3. sensitive to choices of data, parameters, assumptions; 4. not a coherent risk measure (not sub-additive); 5. regulatory usage may encourage herding and increased systemic risk
• [14] General approaches to calculating VaR (3): 1. empirical; 2. parametric (or variance-covariance); 3. stochastic
• [14] Advantages of VaR empirical approach (3): 1. simple; 2. no requirements to specify distribution of returns; 3. realistic
• [14] Disadvantages of VaR empirical approach (4): 1. relies on bootstrapping past data to capture all future scenarios; 2. implies past data is indicative of future experience; 3. does not facilitate stress or scenario testing; 4. limits of interpolation
• [14] Advantages of VaR parametric approach (3): 1. easy to calculate; 2. reduced dependence on past data; 3. easy to adjust parameters
• [14] Disadvantages of VaR parametric approach (6): 1. more difficult to explain than empirical approach; 2. relies on past data to derive parameters; 3. difficult to ensure selected parameters are consistent; 4. assumes parameter values are constant; 5. runs risk of using an inappropriate statistical distribution; 6. complex inter-dependencies are difficult to reflect
• [14] Advantages of VaR stochastic approach (3): 1. can reflect more complex features of underlying losses; 2. produces wider range of possibilities than empirical method; 3. easy to sensitivity test
• [14] Disadvantages of VaR stochastic approach (4): 1. more difficult to explain than empirical and parametric; 2. choice of distribution and parameters can be subjective and difficult; 3. gives a different answer each time; 4. can be computationally intensive
• [14] Advantages of TVaR over VaR (2): 1. considers losses beyond VaR; 2. it is a coherent risk measure
• [14] Disadvantages of TVaR (2): 1. choice of distribution of parameters can be subjective and difficult; 2. highly sensitive to assumptions (more of a concern because uncertain information is used in the tail)
• [14] Disadvantages of Expected Shortfall (3): 1. same disadvantages as TVaR; 2. it has little intuitive meaning; 2. cannot be readily linked to the current valuation
• [14] Considerations in selecting a suitable time horizon (2): 1. expected time to recover from loss; 2. expected time to reinstate risk mitigation
• [14] Considerations in selecting a risk discount rate (5): 1. sponsor’s cost of capital; 2. level of inherent risk exposure; 3. inflation rates; 5. interest rates; 5. rates of return on other investments