FIN 347: Financial Engineering & Risk Management
Spring 2008
Instructor: Peter H. Lou, CFA Instructor’s Biography: Vice president & manager of “Portfolio Analysis & Modeling” at Wells Fargo Wealth Management. Previously served as a senior finance manager at Union Bank of California and as a senior management consultant at Ernst & Young's Management Advisory Services (MAS). M.B.A. from the University of Illinois at Urbana-Champaign. Advanced studies (master and doctoral-levels) at University of Iowa in Policy & Planning. Chartered Financial Analyst (CFA) charterholder since 2000. Guest Lecturer / Speaker: Adrian Shih currently works as an assistant vice president & senior consultant of financial risk management in Wells Fargo Wealth Management. He has a B.S. degree in Economics from UC-Berkeley and has studied as a doctoral student at Columbia University in New York. In his lectures, Adrian will cover topics related to risk analytics, computer-based risk modeling, advanced data modeling / data mining techniques and its applications in financial analysis & risk management. Contact Information:
[email protected] (Subject line: GGU) Location & Time: Downtown S.F., Thursday afternoons. Course website: http://peterlou.pageout.net Class Auditing: Not allowed unless approved by University / instructor. Course Objective & Description: An effective and efficient corporate risk management program leads to knowledge and control of costs (topline) and an improved bottom line (i.e. net earnings). This course deals with the theoretical and practical approaches to effective financial risk management. It covers risk management techniques for corporations and for management of equity, bond, derivatives and investment portfolios. Topics include measurement of corporate risk exposure, portfolio risk exposure and value at risk (VAR) for financial institutions; risk and diversification, modern portfolio theory, efficient frontier, concentrated equity positions, portfolio benchmarking, the importance of asset allocation; market risk management, currency risk exposures, credit risk management, interest rate risks, asset liability management (ALCO), and operational & integrated risk management; and computer applications. For students who are interested in pursuing a career in financial / treasury analysis and financial risk management, a professional accreditation such as Financial Risk Mangers (FRM) or Chartered Financial Analyst (CFA) will be very useful. This course provides you with some of the useful analytical tools in risk management, quantitative methods, portfolio optimization, option analyses necessary for preparing for FRM exam or Levels I, II and III of CFA examinations. The class will be divided into study groups made of about 4-5 students, each of which will work together on case studies. Class participation is important and can favorably affect your grade. Minimum acceptable
participation is regular attendance and completion of the specific assignments. Students may be asked to solve the assigned problems in class. Method of Instruction: A typical lecture will consist of five components designed to reinforce the overall learning process: • • • • •
Lecture notes tied to the textbook (PowerPoint or Word presentations). Problem solving (applying the concepts / theories learned in the class to problem solving). Industry practices / reality checks into the real world applications of the theories learned in the class. Computer-based Learning: Excel is incorporate into problem-solving in certain chapters. Learn by Example (LBE).
Prerequisite: Basic Corporate Finance or equivalent. Text Books: Required Textbooks: Fundamentals of Risk Measurement, Chris Marrison, McGraw Hill, Edition 2002, ISBN: 0-07138627-0. Harvard University Case Studies: http://harvardbusinessonline.hbsp.harvard.edu/b01/en/cases/cases_home.jhtml o Pine Street Capital Product #: 9-201-071 o Cephalon, Inc 9-298-116 o Citibank Hong Kong: Credit Derivatives 9-298-029 o Farallon Capital Management: Risk Arbitrage (A) 9-299-020 o Why Manage Risk 9-294-107 o Framework for Risk Mgt Reprint # 94604 Reference Book: Financial Risk Manager Handbook by Philippe Jorion, Professor of Finance at Graduate School of Business at UC-Irvine. ISBN: 0-471-70629-9. Wiley & Sons. These are to be supplemented by class handouts / articles from leading financial risk management and corporate finance journals. Calculator & Laptop Computer: You need to have a financial calculator by our second meeting. You can use any financial calculator as long as it has the basic financial. Alternatively you can bring in the laptop computer with MS-Excel application. Exams: There will be three mid-term exams (the lowest scores will be automatically dropped) and one comprehensive final exam. Students are required to take the exams at the scheduled time. You can use calculator / laptop computer (limit to Excel) and one sheet of paper (both sides) during the in-class exams. Grading Policy: Class Participation / Attendance Team Project Mid-term Exams Final Exam (Comprehensive)
10% 25% 40% 25%
(two will be counted; 20% each)
Favorable considerations will be given to individuals making progress over time. Weeks
Tentative Topics
Readings
1 (Jan 10)
Introduction; Function of Risk Management
Class handout
2 (Jan 17)
Risk Management and Value Creation; State of the Risk Management Market; Quantitative Techniques: Part I (Introductory) Harvard cases: 1) Why Manage Risk; 2) Framework for RM.
Class handout; Chapter 3
Harvard cases for individual team assigned. 3 (Jan 24)
Quantitative Techniques (Part II; Advanced): Monte Carlo Simulations; Markov Process; Geometric Brownian Motion; Binomial Trees.
Class handout; Chapters 3-4
4 (Jan 31)
Quiz #1: Quantitative & Computer Foundations
All Above (including 2 case studies)
5 (Feb 7)
Measuring Market Risk and Value-at-Risk (VaR); Market Risk Measurement and Drivers; Market Risk Model demos.
Class handout; Chapters 5-11
6 (Feb 14)
Credit Risk Management: Including a discussion of credit risk models by Class handout; Chapters 16Credit Metrics, Credit Risk+, E-Risk, KMV. 17, 20-21, 23
7 (Feb 21)
Interest Rate Risk Management and Interest Rate Swaps; Asset–Liability Management; Credit Derivatives. Harvard cases: Citibank Hong Kong (Capital Arbitrage) Quiz #2: Market Risk (VaR) and Interest Rate Risk Management
8 (Feb 28)
Class handout; Chapters 1215. All since quiz #1 (including case study on Citibank)
9 (March 6) Investment Portfolio Risk Management: Modern Portfolio Theory, Class handout; Chapter 4 Portfolio Benchmarking; Importance of Asset Allocation; Mean-variance Analysis and Portfolio Diversifications; Efficient Frontier. 10 (Mar. 13) Financial Futures Markets; Pricing of Futures; Applications of Swaps, Class handout / journal Caps Floors; Interest Rate Swaps. Dynamic Hedging. Binomial and Blackarticles Scholes Models and Their Applications in Investment Management. 11 (Mar. 20) Foreign Currency Risk Management & Risk Hedging; Operation Risk Management. Legal & Regulatory Risk Management; Integrated risk management. 12 (Mar. 27) Quiz #3: Investment & Foreign Exchange Risk Management Using Options & Derivative Instruments 13 (April 3) Future Trends in Financial Engineering & Risk Management.
Class handout / journal articles All since quiz #2 Class handout
14 (April 10) Team Project & Harvard Case Study Presentations; 30 minutes each team with additional 5 minutes for Q&A.
Team Projects
15 (April 17) Self Study Session (as required by GGU)
Assigned readings
16 (April 24) Final Exam (comprehensive; including assigned case studies)
Comprehensive
Case study assignments (tentative): o Required for all: 1) Why Manage Risk; 2) Framework for Risk Management; 3) Citibank Hong Kong (Capital Arbitrage). Read and review only. o Group 1: Pine Street Capital; Cephalon Inc. Graduate-level analysis and presentations required. o Group 2: Farallon Capital Management: Risk Arbitrage (A). Graduate-level analysis and presentations required.
About the Harvard Business Case Studies Note that the emphases are on: • Developing analytical and judgment skills • Gain exposures to dynamic organizational and managerial situations
• •
Enhance your skills to analyze and defend your opinion as new information or perspectives become available. Incorporate computer modeling techniques (e.g. Macro, what-if analysis, business charting) and Excel spreadsheets where appropriate.
What to Expect in a Case: • Critical issues are not explicit. • Information may be incomplete or ambiguous. • Some information may be redundant / irrelevant. • There are no correct or wrong answers as long as you can justify / substantiate your positions. Sample Guidance (for illustration purpose): Provide a business report (6-8 pages, including cover page, Table of Contents, Reference; graduate schoollevel quality) that includes: • Overview: the issues / business case; the parties involved. • Proposed solutions: Strength analysis. • Proposed solutions: Potential risks involved in this credit derivative deal. • Critique / evaluate on the proposed “talk points” to clients. • Develop a set of recommendations supported by your analysis. Evaluate alternative proposals (pros and cons). Address the implementation issues in an applied corporate setting. • Provide some analysis of the bond features in Exhibit 1, e.g. coupon frequency, discount vs. premium bond, etc. • Concluding remarks; Reference.