1.  The New Risk Management The Good, the Bad, and the Ugly Author : Philip H. Dybvig, Pierre Jinghong Liang, and William J. Marshall Presented By: Yiji Gu

2. New Risk Management  New VS. Old  Old  Buy corporate insurance  Avoid lawsuits and accidents  Install safety equipment  New  Use financial markets to hedge against interest rate risk, currency fluctuations…etc

3. Tools for hedging  Options  Black-Scholes model  Matching beginning value and ending value  Losing money in good times and making money in bad times

4. Example Naive Hedge Unhedged Cash Flows Fully Hedged

5. Example Price Dynamics

6. Example-Dynamic Hedging  Reinvestment rate  Reinvested proceeds of the hedge + original cash flow is the same in every contingency

7. Four Questions to ask  Why should we hedge?  What risk should we hedge?  With what instrument should we hedge?  Support your investment banker

8. Why should we hedge  Reduce the volatility of the value received by shareholders  Avoid potential ancillary damage within the firm.  i.e. bankruptcy, increase tax  A policy of smoothing earning  Give managers incentives to produce profits

9. What risks should we hedge  i.e. interest rate risk  Directly hedge the mismatch of existing assets and liabilities  Or hedge the full economic value that includes the value of future business  Hedge cash flows or value

10. Accounting issues  Hedge accounting treatment  Fair value hedge VS Cash flow hedge  Conditions  Failure to qualify as a hedge often penalize true economic hedging  Hedges that are economically equivalent may have very different accounting treatment

11. Cost  Transaction cost  Liquid market  Custom contracts  Marginal cost  Spot market price

12. Risk Management Policy  Control system  Goals of hedging program  Ex post evaluation

13.  Thank You Yiji Gu