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Financial Risk Management (FRM)

Course Instructor:
Dr HK Pradhan
Professor of Finance & Economics
XLRI Jamshedpur
Introduction:
Globalization of finance and diversification of assets holdings of financial institutions have
created opportunities as well as risks. In recent periods global factors have predominated
domestic asset returns and volatility. Financial market prices (e.g stocks, bonds, currency &
commodities) have displayed considerable volatilities, predominantly influenced by the global
factors, thereby exposing to severe potential downside exposure banks and corporations. The
Indian rupee depreciated significantly, responding to portfolio outflows and speculative
pressures. Regulators have shown increasing concern responding to such unprecedented
volatility, requiring the institutions to safeguard their balance sheets. Macroeconomic policy
making has become increasingly complex, for example, the QE factors in US or commodity
prices in China, all can exacerbate domestic crisis. Often market participants require sound
analytical framework while operating in fast changing global environment.
Objectives:
This course proposes to deal with the globalization of finance and implications on Indian
institutions, understanding of global currency, commodity and bond markets, risk implications in
asset markets in an interconnected world, and mechanisms to measure and manage financial
risks in particular. The course analyzes approaches to risk measurement and management,
learning from international best practices as financial disasters globally. It equips future
managers with financial management skills with cross border operations.

Evolving World of Finance & Risk


Interest Rates and Currency Assets & Arbitrage
Global Investment Strategies, Mutual Funds & Hedge Funds
Risk Measurement in Asset Classes(currency, bonds, commodity, equity )
Measure volatility in market prices,
Measure Value-at-Risk and its implications,
Statistical Techniques, Simulation: Historical & Monte Carlo
Lessons from some financial risk & disasters.

Pedagogy:
The course dwells on lectures, extensive calculations of risk analytics using excel(volatility, Var,
simulations techniques, option pricing), understanding asset prices and their arbitrage using
Bloomberg, exercises in groups using market data; and case analysis. It attempts to provide the
basic foundations to work in a world of finance with risk and arbitrage. It will equip students in
analytical as well measurement tools of financial risk, and is therefore should be relevant for
those looking at a career opportunity in a global institution.

Session Details:
1. The Evolving World of Finance & Risk..1
Risk Environment in Global Banking & Finance, Emergence of Asset Classes
& their Risk-Arbitrage Implications, Episodes of Financial Crisis, Euro
crisis, Alchemy of Finance under Globalization
2. Risk Measurement Approaches2,3
Return & Risk, Return Distribution, Volatility Measurement Techniques (SD,
Exponential Weighted, GARCH processes, Implied Volatility, VIX)
Volatility Clustering, Correlation & Volatility during market crash, Implications on Risk
3. Market Risk Measurement Techniques4,5, 6,7
Measuring risk using Value-at-Risk(Var), Variance-Covariance Approach.
VaR using historical simulation methods, Stress testing and back-testing,
expected shortfall in historical simulations.
Introduction to Monte Carlo simulation, Var using Montecarlo; Forecasting
correlation & Volatility during market crash, Extreme Value Methods, Jump Diffusion
4. Sector Risk Analytics: Fixed Income Markets & Bond Investing.8
Interest Rate Markets & Their Risk Measurement, Measurement of Duration, Convexity,
M-Square, Active vs Passive Portfolio Risk Management
5. Sector Risk Analytics: Currency Markets, Trading & Arbitrage9
Spot & forward markets dynamics, Parity Conditions in Global Finance, Currency
Arbitrage, Corporate strategies under parity imperfections, Currency Fundamentals
6. Sector Risk Analytics: Risk Management in equity portfolio.10
Various Risk Metrics, Concept of Beta for trading and risk management, Explanations of
various Risk terminologies ( Alha, Beta, Sharpe Ratio, Sortino Ratio), Global Asset
Management Practices
7. Sector Risk Analytics: Commodity Markets as alternate asset class..11
Key Differences in Commodity & Other Asset Classes, Backwardation &
Contango, Commodity Hedging Instruments, Global and Indian Commodity
Market Interactions(metals, energy and agri -commodities)
8. Measuring and Managing Credit Risks, Credit Derivati ves.12,13,14
Credit Risk Basics(PD, LGD), Market based measurement of credit risk,
Contingent claim approach and the KMV Model, Credit VaR, Credit Derivatives &
the Case of Sub-prime Crises,
9. Country Risk Ratings & Implications.15

Country Risk Assessment (S&P Methods), Methods (Checklists, Delphi,


Combination techniques, etc), Country Risk and Corporate Exposure,
Incorporating Country Risk in decision making(adjusting for country beta).
10. Other Financial Risks (Liquidity, Operational, Trading risk).16,17
Liquidity trading and funding risks, Categorization of Operational Risks(loss
severity and loss frequency), measurement techniques in Liquidity &
Operational Risk
11. Crises & Risk Management Lessons18, 19, 20
Role of Basel-II in global financial crisis and Limitations of Basel-II, Economic Capital
vs. Regulatory Capital, Basel II & Capital Adequacy.
Case Discussions (Orange County, Barings, Kidder Peabody, Metallgesellschaft,
Northern Rock, Procter and Gamble (P&G), US Savings & Loan Crisis, etc).
Evaluation Criteria: The course objectives are achieved by extensive in-class exercises,
end-class quizzes, individual assignments, case analysis & presentations,
Assignment Submission(Group of 5)
15%
Case Analysis/presentations(Group of 5)
15%
Quizzes (3)
30%
Final Exam
30%
Attendance
10%
(Attendance compulsory, missing one class = 1-mark deduction)
Reading: The texts recommended for this course:
John Hull, Risk Management and Financial Institutions, 3rd Edition, 2013.
(Other important references will be provided)
Other handouts: The course will provide several articles, empirical techniques in risk
management, as well as my presentations, excel spreadsheet calculations, templates from
Bloomberg as well as web resources.
Assurance of Learning (AOL)
In a course on financial risk, students are expected to learn how to quantify risk from market
data, understand the regulatory in measuring risk and risk-based decision making, and manage
risk using risk management techniques. The evaluation components will dwell on these aspects,
which is given in the following:
Components

Assignment
Submission

Visualization
of problem

Analysis of the
information
Information in
the domain of

Narrowing on
the Solution

Identifying
conceptual
frameworks

Application of
conceptual
frameworks
Use the
conceptual

risk needs to
be collected
and analyzed

Case
Analysis/
presentations

Identify and
discuss how
the case
handled the
specific
situation

Quizzes

Final Exam

Class
Attendance/pa
rticipation

framework/models
discussed to
analyze the
specific
assignment
Evaluate if the
case uses the
modern approach
to risk
management

Understanding
of the
information
provided and
their
applications in
real world
situation
Ability to
Information in
visualize,
the domain of
articulate and risk needs to
frame the
be collected
problems
and analyzed
discussed
and
deliberated.

The quizzes will


test the students
ability to
understands
models and
measurement
techniques of risk
The end term will
test the students
ability to
understands
models and
measurement
techniques of risk
Encouraged to
bring in
innovative
approaches to
the problem
discussed

Calculations of
risk should
involve the
application of
exact models as
discussed in the
class.