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Finance 562: Enterprise Risk Management Professor Stephen P
Finance 562: Enterprise Risk Management Professor Stephen P. D’Arcy and Professor Weili Lu Lecture 9 Part B: Review
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Lecture 6 – Risk Measures
Types of risk measures Risk control Risk optimization Hazard risk Financial risk Operational risk Strategic risk
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Hazard Risk Management Analytics
Probable Maximum Loss (PML) Maximum Possible Loss (MPL) Loss Frequency Loss Severity Actuarial Models Loss Distributions
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Financial Risk Management Analytics
Interest Rate Sensitivity Measures Duration and convexity Interest Rate Models Equilibrium models and arbitrage free models Value-at-Risk (VaR) Parametric Monte Carlo simulation Historical simulation Asset/Liability Management (ALM)
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Credit Risk Analytics Credit Scoring Models Credit Migration Models
Credit Exposure Models Credit Portfolio Models Financial models Econometric models Actuarial models
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Operational and Strategic Risk Analytics
Analytic methods are primitive Top-Down Approaches Analogs Remove identifiable risks first Remaining risk is classified as operational risk Historical loss data Bottom-Up Approaches Self assessment Cash flow model
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Lecture 6 – Basic Questions
Compare risk control vs. risk optimization Use different measures Explain and calculate VaR
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Lecture 6 – Example 1 Given two projects which would you choose and why? Project A Expected return on capital = 16% Expected risk adjusted return on capital = 12% Project B Expected return on capital = 20% Expected risk adjusted return on capital = 10%
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Lecture 6 – Example 2 For a medium size insurance company with a book of property insurance and an investment portfolio PML = $10,000,000 Daily 99% VaR = $10,000,000 Explain this distinction to the Board
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Lecture 7 – Interest Rate Risk
Asset-Liability Management Duration and convexity Term structure shapes Factors Level Steepness Curvature
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Simplifications with Duration and Convexity Calculations
Fixed income, non-callable bonds Flat yield curve Parallel shifts in the yield curve
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Term Structure Shapes Normal upward sloping Inverted Level Humped
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Lecture 7 – Basic Questions
Calculate duration and convexity for simple cash flows Apply duration and convexity Explain limitations Identify term structure shapes Calculate level, steepness and curvature
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Lecture 8 – Risk Management Tools
Pooling Hedging Controlling Planning Catastrophe bonds
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Basic Building Blocks of Hedging
Forwards Futures Swaps Options
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Lecture 8 – Basic Questions
Explain when does each risk management tool work Explain need for cat bonds Which building block has One sided risk Highest credit risk Which tool would be applicable for specific conditions
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Lecture 8 - Examples Life insurer sells annuity indexed to inflation
Which tool would allow insurer to deal with risk of high inflation rate? A financial firm has sold a large number of credit default swaps in which it receives a periodic premium and guarantees to pay any credit (default) losses Which tool would allow this firm to manage its credit risk?
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Guest Lectures Bob Wolf – ERM Overview Hank McMillan – Pacific Life
David Axene – Health Care Risks Bob Finger – Severe Events James Lam - ERM Grace Crickett – Role of CRO in Public Institution
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Conclusion Understand key concepts Organize class notes
Be prepared to explain main concepts Be able to perform basic calculations Be able to apply risk management tools Be prepared to explain limitations of metrics and tools
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