Financial Risk Management

Course Syllabus

Personal Information

• Instructor Name: Ming-Yuan Leon Li

• Instructor Tel: Ext 53421

• E-mail: lmyleon@mail.ncku.edu.tw

• Office Hours: – Wednesday: 10:00-12:00 AM

• Office Number: 63315

Course Descriptions/Objectives

• Help students to better understand the topic relating to “financial risk management” by textbook studying and extra handouts.

• The goals of this course are the following ：– Provide quick access to the whys and how of risk man

agement – Provide easy-to-understand information, including equ

ations and examples that can be quickly applied to most risk management problems.

– Provide information about how risk measurement is used in the management of risk and profitability

Course Descriptions/Objectives

• After studying the course , you should be able to answer the following four questions：– How much could we lose ？– Can we absorb a significant loss without going

bankrupt？– Is the return high enough for us to take risk？– How can we reduce the risk without significant

ly reducing the return？

Grading

• 1st Exam (25%): held in the 7th week

• 2nd Exam (25%): held in the 13th week

• 3rd Exam (30%): held in the 18th week

• Class participation (20%)

Grading

– Class participation• Homework

–Writing report and/or oral report

• Quick Quiz–In the ending of each chapter, I will

provide a quick quiz including several simple questions to review today's content

–Your performance will be evaluated into your score

Textbook

• Chris Marrison, Fundamental of Risk Measurement– Book store: 新陸書局– Mr. 江 , 0936-968488– TEL: 02-2381-9277

Course Calendar/Schedule

• Before 1st Exam:– The Basic of Risk Management (Ch 1 to Ch 2)– Market Risk Management (Ch 5 to Ch 8)

• Between 1st and 2nd Exam:– Market Risk Management (Ch 9 to Ch 11)– Asset Liability Risk Management (Ch 12 to Ch 13)

• After 2nd Exam:– Asset Liability Risk Management (Ch 13 to Ch 15)– Credit Risk Management (Ch 15 to Ch 19)

Course Policies

• The purpose of this class is to identify the hidden agenda in this subject

• I will follow the textbook to present the important topics of risk management, especially for banks

• It is expected that every student attend all classes and take all examinations when scheduled

• In order to maximize your learning and to receive credit for your classes, you must attend at least 80% of classes

Slides

• The slides in PowerPoint file

• How to find them– My personal web-site– http://140.116.51.3/chinese/faculty/mingyuan/

myweb11/index.htm

• Some suggestions– Download them and study them before the

class

Certain Important Perspectives Review

• What is the risk?– A potential loss in the future

• How to measure the risk– Use the historical data to simulate the distribution of

return rate of your portfolio– For example, 2-year data to picture the distribution

curve– Assume the return rate in the next trading day will be

drawn from the same distribution• How to picture the distribution?

– Mean and Standard errors – Correlation coefficients

Some Important Perspectives Review

• Two Examples– The daily return rates of U.S. S&P 500 stock i

ndex– The daily return rates of Taiwan company: Ac

er 2353

Distribution of Return Rate for U.S. Market

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

-4 -3 -2 -1 0 1 2 3 4

Use 2-yea data (near 500 daily return rates data) to simulate the underlying distribution of return rates of our portfolio

Rt, for t=1 to 500

Assume the return rate in the next trading day is drawn from the same distribution

Rt, for t=501,502, …

Standard error, σ

Standard error, σ

If we assume the return rate follows the normal distribution, then the potential loss can be presented by standard error

Distribution of Return Rate for U.S. Market

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

-4 -3 -2 -1 0 1 2 3 4

Standard error, σ (0.94%)

Standard error, σ

(1)If we assume the return rate follows the normal distribution, then the potential loss can be presented by standard error

(2) The P[ return rate<-2.33Xσ]=1%

The P[ return rate<-1.96Xσ]=2.5%

The P[ return rate<-1.645Xσ]=5%

(3) If we assume the initial investment money is 100,000, the loss of ”>100,000X 2.33Xσ” in the next day will have 1% probability of occurrences

Homework (1)

• Please pick up one company• Figure the distributions of their daily stock price

returns• One-year daily data at least• Estimate its mean and standard error • Assume the initial investment is 1 million dollars

(1,000,000)

• Calculate the potential 1% loss in the next day

Homework (1)

• Does the distribution follow a normal distribution?– Normalize the returns: (returns-mean)/SD– The 1% critical value of the distribution vs. 2.3

3

More Discussions

• One asset versus Portfolio?– Variance and covariance/correlation– Risk contribution?– stock: 100 units, bond: 50 units; – Q: a portfolio=stock + bond: 150 units?

• Normal distribution?

• Other types of risk?

Structure of Financial Risk Management

• Define the risk– Market risk– ALM risk

• ALM interest rate risk• ALM liquidity risk

– Credit risk

• Measure the risk– Use the historical data to picture the

distribution of the loss

Structure of Financial Risk Management

• Manage the risk– Reduce the risk

• Hedge• Diversification

– Capital preparation– Risk allocation

• Which unit takes the risk?

– Performance evaluation• Risk-adjusted performance

Market Risk

Credit Risk

Floating rate vs. Fixed rate: interest rate risk

Long-term vs. short-term: Liquidity Risk