NES Masters in Finance
RISK MANAGEMENT
March-April 2011
Professor: Alexei Goriaev ( agoriaev@nes.ru
)
T.A.: Andrey Prudnikov ( andrey.prudnikov@gmail.com
) – seminars
Rodion Lomivorotov ( l.rodion@gmail.com
) – grading
Summary
This course will provide you with effective tools of managing risks faced by the firm. We shall examine a broad range of risks: from financial risks measured by statistical models to those risks, which are hard to quantify yet are not less influential for the firm. The course structure is based on a holistic framework of enterprise-wide risk management (ERM), which includes identification, evaluation, treatment, and monitoring of risks. We start with motivation for risk management in a corporation, discussing various risks and basic approaches to deal with those risks in accordance with the firm’s goals. Then, we examine how to measure market and credit risk using statistical methods, with focus on Value at Risk (VaR). In addition to that, we discuss how to evaluate operational, political, social, and other ‘soft’ risks. Then, we consider the execution of risk strategy in a company using ERM approach, with focus on the role of CRO. We round up the course with discussion of the future prospects of risk management taking into account lessons from the current financial crisis.
Numerous real-world examples and cases will be used to illustrate application of given concepts.
Course materials
[1] is a required reading for the course. [2] and [3] may serve as complementary readings for topics related to market, credit, and operational risk. [4] is an advanced reading describing the framework of enterprise-wide risk management and its implementation in the firm.
1.
Круи, М., Галай, Д., Марк, Р., 2011, Основы риск-менеджмента, Юрайт.
2.
Hull, John C., 2007, Risk Management and Financial Institutions, Prentice-Hall.
3.
Hull, John C., 2006, Options, Futures, and Other Derivatives, Prentice-Hall (sixth edition).
4.
Lam, J. (2003) Enterprise Risk Management: From Incentives to Controls. Wiley.
In addition, students are required to read several articles on risk management:
 Berkowitz and O’Brien, 2002, How Accurate are Value-at-Risk Models at Commercial Banks?
Journal of Finance 57.

Jorion, 2000, Risk Management Lessons from Long-Term Capital Management, European
Financial Management 6.

Fraser and Simkins, 2007, Ten Common Misperceptions about ERM, Journal of Applied
Corporate Finance.
During the course, the following cases will be covered in depth:

Risk Management at Wellfleet Bank: Abridged (HBS case 9-110-011)

Enterprise Risk Management at Hydro One (HBS case 9-109-001)

JP Morgan Private Bank: Risk Management during the Financial Crisis 2008-2009 (HBS case
9-311-003)
Besides the required materials, students are encouraged to read books of N. Taleb: “Fooled by
Randomness” and “Black Swan,” which provide unorthodox view on the nature of risks.
Course requirements and grading
The course grade will be based on three cases (30%), three home assignments (30%), and closed-book final exam (40%). If you have any questions on home assignments, you can send them by e-mail to
TA.
Cases must be prepared in groups of 3-4 people. Work on the case involves preliminary group discussion, writing a case report answering given questions, and being ready to present your solution in the class with slides. The case report should contain problem statement (including relevant information from the case), analysis (assumptions, arguments, computations, optimal and alternative
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solutions), and conclusions (summary of your logic and recommendations). It should be written as executive report to your superior; the maximum length is 3 pages (all tables and supporting data can be put into a separate appendix). The report must be based on information contained in the case and your own analysis, not on someone else’s solutions that may be available at the web (I will check those to ensure there are no similarities). It should be submitted by the beginning of the class discussing the case. Each case contributes 10% to the total points for the grade. If someone is not ready to discuss the case in the class and cannot answer two questions, he or she receives zero points for a given case.
The class participation may contribute to the grade, if it is on the margin. Not quantity, but quality of your interventions will count. Thus, try to effectively prepare to each class by doing pre-reading of the assigned materials.
Course outline and readings
Class Topic Reading
1 Definition of risk. Motivation for risk management. Mapping
Mar risks that corporations face. Main methods of managing risks.
9 Risk management as a part of corporate strategy
In-class discussion of the mini-case: American Barrick
[1] ch.1-2
[2] ch.1-2
[4] ch.3
2
Mar
14
Hand in home assignment 1
Risk vs. return, diversification. Market risk: volatility, exposure, greeks, and VaR. Delta-normal, historical, and
Monte Carlo approaches to measure VaR. Back-testing of
VaR. Alternatives to VaR.
3
Mar
21
Hand in home assignment 2
Stress testing. Liquidity risk. Model risk.
In-class discussion of the mini-case: LTCM
Specifics of credit risk. Credit risk: modeling recovery rate, credit exposure and probability of default. Credit ratings.
[1] ch.5, 7 (161-182)
[2] ch.5, 8.1-8.6, 9-10
[3] ch.18-19
Berkowitz and O’Brien (2002)
[1] ch.7 (183-188), 14, 10 (238-
245)
[2] ch.8.7, 15
Jorion (2000)
4
Mar
30
Hand in case solution&be ready to discuss: Wellfleet Bank
Internal credit ratings and scoring models. Modeling credit spread. Advanced models of credit risk: CreditMetrics,
Merton’s model and KMV Portfolio Manager.
Managing credit risk. Credit derivatives.
5 Hand in home assignment 3
Apr
6
Operational risk. In-class discussion of the mini-cases:
Barings, Societe Generale, Madoff.
Other ‘soft’ risks: political, legal, environmental, social, etc.
Guest speaker: TBA
[1] ch.10-12
[2] ch.11-13
[3] ch.20-21
[1] ch.13
[2] ch.14, 15.1-15.6
[4] ch.5
6
Apr
14
Hand in case solution&be ready to discuss: Hydro One [1] ch.4,15
The practice of enterprise risk management (ERM). Role of [4] ch.3-4, 6
CRO. ERM and corporate governance. Use of risk measures in Fraser and Simkins (2007) the company: performance evaluation, managerial compensation, intra-firm capital allocation, etc.
7
Apr
20
Hand in case solution&be ready to discuss: JP Morgan
Managing risks during the crisis. Lessons from the crisis. The future of risk management.
Guest speaker: TBA
[1] 377-387
[2] ch.18
[3] ch.32
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Additional key dates (preliminary)
March 19: seminar 1, In-class discussion of the mini-case: Metallgezelschaft. Preparation of HA2
(measurement and back testing of VaR)
April 2: seminar 2, Preparation of HA3 (Credit Metrics)
April 30: exam
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