Corporate and Project Finance Modeling

Chapter 14Defining, Describing, and Assessing Risk in a Risk Allocation Matrix

The first step in assessing risk is often to categorize, describe, and put some kind of subjective probability weight on different risks in a structured manner rather than diving into any quantitative analysis. At this stage of the analysis, a financial model is not part of the process. The idea of categorizing risks by writing them down in a table should force you to think about, discuss, and understand a variety of different risks; how the risks may be mitigated by contracts; the likelihood of the risks occurring; the magnitude of the problem if the risks arise and how those risks could potentially affect investment returns. Qualitative analysis may involve preparing a memo on key risk issues, categorizing various risks into a matrix that describes the risks, or some other similar approach. This first step of risk analysis highlights the problem with lack of transparency when a company uses fancy financial language that may be a method of hiding real problems. Without information being presented in a transparent manner and without access to data that allows assessment of value drivers, analysts cannot even identify the risks.

In creating a structured list of potential risks, the matrix can become rather boring and mechanical where construction delay risks are mitigated by liquidated damages, interest rate changes are mitigated by interest rate swaps, operation and maintenance (O&M) expenses are ...