1. 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

2. Lecture 6 – Risk Measures
Types of risk measures
Risk control
Risk optimization
Hazard risk
Financial risk
Operational risk
Strategic risk

3. Hazard Risk Management Analytics
Probable Maximum Loss (PML)
Maximum Possible Loss (MPL)
Loss Frequency
Loss Severity
Actuarial Models
Loss Distributions

4. 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)

5. Credit Risk Analytics Credit Scoring Models Credit Migration Models
Credit Exposure Models
Credit Portfolio Models
Financial models
Econometric models
Actuarial models

6. 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

7. Lecture 6 – Basic Questions
Compare risk control vs. risk optimization
Use different measures
Explain and calculate VaR

8. 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%

9. 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

10. Lecture 7 – Interest Rate Risk
Asset-Liability Management
Duration and convexity
Term structure shapes
Factors
Level
Steepness
Curvature

11. Simplifications with Duration and Convexity Calculations
Fixed income, non-callable bonds
Flat yield curve
Parallel shifts in the yield curve

12. Term Structure Shapes
Normal upward sloping
Inverted
Level
Humped

13. 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

14. Lecture 8 – Risk Management Tools
Pooling
Hedging
Controlling
Planning
Catastrophe bonds

15. Basic Building Blocks of Hedging
Forwards
Futures
Swaps
Options

16. 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

17. 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?

18. 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

19. 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