Finance School of management Chapter 10: An Overview of Risk management Objective . Risk and Financial Decision Making Conceptual Framework for Risk management .Efficient Allocation of Risk-Bearing uesTc
1 Finance School of Management Chapter 10: An Overview of Risk Management Objective •Risk and Financial Decision Making •Conceptual Framework for Risk Management •Efficient Allocation of Risk-Bearing
Finance School of management Contents 10.1 What is risk? 10.2 Risk and Economic decisions 10.3 The risk Management Process 10. 4 The Three Dimensions of risk Transfer 10.5 Risk Transfer and Economic efficiency 10.6 Institutions for Risk Management 10.7 Portfolio Theory: Quantitative Analysis for Optimal risk management 10.8 Probability Distributions of Returns 10.9 Standard deviation as a measure of risk uesTc
2 Finance School of Management 10.1 What is Risk? 10.2 Risk and Economic Decisions 10.3 The Risk Management Process 10.4 The Three Dimensions of Risk Transfer 10.5 Risk Transfer and Economic Efficiency 10.6 Institutions for Risk Management 10.7 Portfolio Theory: Quantitative Analysis for Optimal Risk Management 10.8 Probability Distributions of Returns 10.9 Standard Deviation as a Measure of Risk Contents
Finance School of management Roles of risk management One of the three analyticalpillars"to fin nance Risk allocation(redistribution) uesTc
3 Finance School of Management Roles of Risk Management ❖One of the three analytical “pillars” to finance ❖Risk allocation (redistribution)
Finance School of management Concept of risk Uncertainty that is bad iLlustration: preparing foods for party Gains or losses: upside" potential or downside" possibility uesTc
4 Finance School of Management Concept of Risk Uncertainty that is “bad” ❖ Illustration: preparing foods for party ❖ Gains or losses: “upside” potential or “downside” possibility
Finance School of management Risk aversion Prefer lower risk given same expected value .o Diminishing marginal utility of income .o a measure of willingness to pay to reducing risk o A characteristic of one's preference in risk-taking situations Rational behavior assumed to be risk-averse uesTc
5 Finance School of Management Risk Aversion Prefer lower risk given same expected value ❖ Diminishing marginal utility of income ❖ A measure of willingness to pay to reducing risk ❖ A characteristic of one’s preference in risk-taking situations ❖ Rational behavior assumed to be risk-averse
Finance School of management Risk management The process of formulating the benefit-cost trade-offs of risk reduction and deciding on the course of action to take .o The appropriateness of a risk-mgmt decision judged in the light of the information available skill or lucky of a decision-maker? uesTc
6 Finance School of Management Risk Management The process of formulating the benefit-cost trade-offs of risk reduction and deciding on the course of action to take ❖ The appropriateness of a risk-mgmt decision: judged in the light of the information available ❖ Skill or lucky of a decision-maker?
Finance School of management Risk exposure Particular types of risk one faces due to ones circumstances Ⅲ lustrations: Farmer: a crop failure and a decline in the price house owner: fire, theft, storm or earthquake damage, a decline of house price mporter/exporter: change of currency exchange rate O Assessing risk exposure in context uesTc
7 Finance School of Management Risk Exposure Particular types of risk one faces due to one’ s circumstances ❖ Illustrations: – Farmer: a crop failure and a decline in the price – house owner: fire, theft, storm or earthquake damage, a decline of house price – Importer/exporter: change of currency exchange rate ⚫ Assessing risk exposure in context
Finance School of management Speculate and Hedge Speculate: taking positions that increase exposures to certain risks Hedge: measures that reduce risk exposures uesTc
8 Finance School of Management Speculate and Hedge ❖ Speculate: taking positions that increase exposures to certain risks ❖ Hedge: measures that reduce risk exposures
Finance School of management Ri ISKS EXposure for Households Sickness disability, and death Unemployment Consumer -durable asset risk Liability risk 5 Financial-asset risk uesTc
9 Finance School of Management Risks Exposure for Households 1. Sickness, disability, and death 2. Unemployment 3. Consumer-durable asset risk 4. Liability risk 5. Financial-asset risk
Finance School of management Risks Facing Firms Production risk Price risk of outputs 3 Price risk of inputs uesTc 10
10 Finance School of Management Risks Facing Firms 1. Production risk 2. Price risk of outputs 3. Price risk of inputs