INSURANCE 811

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INSURANCE 811

• Neil Doherty

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Risk Management

• Personal RM
• Insurance for house and car, pension, etc
• Investor RM
• Diversification, derivatives, etc
• Country RM
• World Bank helps countries manage catastrophe
  risk
• Corporate RM

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Corporate Risk Management

• Corporate RM
• Mitigate risk
• Safety - quality control - information backup
  crisis management
• Make firm more robust to big shocks
• More capital - contract labor - lower
  leverage
• Preserve ability to create value
• Continued funding for investment after loss -
  resolve principal/agent issues
• Transfer risk to counterparty
• Insurance - hedging with derivatives -
  contract risk to customers/subcontractors, etc.
• Manage risk to transmit appropriate information
• Selective hedging to purge noise
• Managerial compensation and risk management
• Trade off risk and motivation - induce manager
  to create value through RM

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Why should a firm worry about managing risk?

• Consider you are an investor who owns shares of
  an oil company
• The firms managers say they are concerned about
  the effect of oil price changes on firm profits
  and value
• But they can hedge this risk
• Do you, the investor want the firm to hedge oil
  price risk?

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Why should a firm worry about managing risk?

• Arguments why you may not want the firm to hedge
  oil price risk - By hedging the risk, the firm
  will give up some expected value to reduce
  volatility
• You, as a diversified investor can control the
  risk/return relationship by choosing which stocks
  to hold in your portfolio.
• Alternatively, you are not a diversified
  investor. You bought oil shares to take a
  speculative position in oil risk. You can control
  the risk of this position by buying oil futures
  if you wish.
• Either way, why would you want the firm to do
  what you can do by yourself i.e control risk
  and return?

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Why should a firm worry about managing risk?

• We need to answer the above question
  convincingly, before we can start thinking about
  corporate risk management
• We will show how risk can deplete firm value
• What risk management strategies can restore firm
  value

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Syllabus

• 1/11/05. Overview of course.
• 1/13/05. A primer on Options
• 1/18/05 - 1/20/05 - 1/25/05
• Why is risk costly to firms
• 1/27/05 Post-event Financing.
• 2/1/05 Contingent Financing.
• 2/3/05 Case, Cephalon Inc.
• 2/8/05 Leverage and Structured Debt.
• 2/10/05 Hedging and Insurance.
• 2/15/05 Case, Metallgesellscaft.
• 2/17/05 Case, Apache.
• 2/22/05 Risk and Capital Management
• 2/24/05 Case Collateralized Loan Obligations and
  the Bistro Trust

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Blending cost-of-risk theoriesand transparency
theory