RISK MANAGEMENT

by

Required textbook: Hull, J. (2018) Risk Management and Financial Institutions (5th edition).

    

FIN 562 Winter 2021 Final Project 

The questions relate to chapters and respective lectures of 23, 24, 25, 27, 28, & 29 of the Hull book. If you have any calculations, please show them in your answers. 

 

1) 

Consider the following three events: 

  1. 1)  An insurance company loses $5 billion due to an earthquake in California.
     
  2. 2)  An auto manufacturer loses $5 billion from a lawsuit relating to safety flaws of a new car
    design.
     
  3. 3)  A food processing firm loses $5 billion from a hedging trader speculating in the coffee and
    sugar markets.
     

You have equal investments in the three firms. Which loss or losses are you more concerned about? Why or why not are you concerned? Are there any risk management issues you can point to in these firms? 

2) 

A hedge fund wants to purchase 100 shares of company X. The bid = $70, offer = $80. They also want to purchase 200 shares of company Y. The bid = $15, offer = $25. 

  1. 1)  What is the proportional bidoffer spread of each company?
     
  2. 2)  What is the midmarket total value of each position?
     
  3. 3)  What is the cost to the hedge fund to unwind the portfolio?
     
  4. 4)  If the bidoffer spreads are normally distributed with mean $10 and standard deviation $3,
    what is the 99% worst-case cost of unwinding the position in the future?
     

3) 

You are consulting to a financial institution that uses an imprecise model for pricing and hedging a particular type of structured product. 

  1. 1)  Discuss how, if at all, it is likely to realize its mistake.
     
  2. 2)  As the risk management consultant, what procedures would you recommend mitigating the
    institutions model risk?
     

  

4) 

A fund’s risk appetite wants to be 90% certain it will not lose more than 20% in any one year. Based on the following variables, calculate the beta the fund should have. 

R = -0.20, RF = 0.03, RM = 0.082, M = 0.15, and p = 0.9 5) 

When thinking about the cycle of innovation, discuss the following items: 

  1. 1)  What causes disintermediation?
     
  2. 2)  Name three fintech items and what is their impact on traditional intermediaries
     
  3. 3)  What is a common reason for financial institutions to reject fintech products and what can a
    fintech firm do to reduce rejection risk?
     

5)

You are a risk consultant to a financial institution. Your client asks you to respond to the following two questions: 

  1. 1)  What are the two common factors for firms to have large losses?
     
  2. 2)  List and discuss at least four actions you recommend the client to take to avoid risk
    management mistakes.