Course Catalog Description
This course deals with risk management concepts in financial systems. Topics include identifying sources of risk in financial systems, classification of events, probability of undesirable events, risk and uncertainty, risk in games and gambling, risk and insurance, hedging and the use of derivatives, the use of Bayesian analysis to process incomplete information, portfolio beta and diversification, active management of risk/return profile of financial enterprises, propagation of risk, and risk metrics.
Risk Control and derivative pricing are major concerns for financial institutions. Yet, as recent events have shown us there is a real need for adequate statistical tools to measure and anticipate the amplitude of the potential moves of the financial market. Many of the standard models seen on Wall Street however are based on simplified assumptions and can lead to systematic (and sometimes dramatic) underestimation of real risks. Starting from a detailed analysis of market data, one can take into account more faithfully the real behavior of financial markets (in particular the ‘rare events’) for asset allocation, derivative pricing and hedging, and risk control.
Various financial instruments will be presented in a form familiar to Wall Street traders (i.e. Bloomberg screens). The purpose of Risk Management is to provide a valuation of these financial contracts ("pricing") and to provide various measures of risk and methods to hedge these risks as best as possible ("hedging"). These tasks are not just performed by "Risk Managers" but by "Traders" who price and hedge their respective trading books on a daily basis. Successful trading (over extended periods of time) comes down to successful risk management. Successful risk management comes down to robust valuation which is the main prerogative of Financial Engineering. Valuation of financial instruments begins with an analysis of possible future events (i.e. stock price moves, interest rate moves, defaults, etc.). Dealing with the future involves the mathematics of statistics and probability. The first step is to find a probability distribution that is suitable for the financial instrument at hand. The next step is to calibrate this distribution. The third step is to generate future events using this calibrated distribution and based on this, provide the necessary valuation and risk measures for the financial contract at hand. The failure of any of these steps can lead to incorrect valuation and therefore an incorrect assessment of the risks of the financial instrument under consideration.
All the homework assignments require the use of Excel with the following properties:
d. Skew(), Kurt(), Average(), Stdev(), Frequency()
2) Data Analysis Function: Histogram
Attention Apple Users: Even though you may have Excel, the above functionality does not come with all Apple versions of Excel so you better check to see what your Excel provides.
Homework Mostly in Excel.
Exams In-class and closed book
Homework assignments must be uploaded to the Canvas shell of the course.
Practical Methods of Financial Engineering and Risk Management, Rupak Chatterjee, Apress-Springer, 2014.
Risk Management and Financial Institutions, John Hull, John Wiley & Sons, 2012.
Monte Carlo Methods in Financial Engineering, Paul Glasserman, Springer-Verlag, 2004.
Fixed Income Securities, 3rd Edition, Bruce Tuckman & Angel Serrat, Wiley Finance, 2012.
Gareds will be based on:
50% Final Exam
EXAM ROOM CONDITIONS
The following procedures apply to exams for this course. As the instructor, I reserve the right to modify any conditions set forth below by printing revised Exam Room Conditions on the exam.
1. Students may not use the following devices during exams. Any electronic devices that are not mentioned in the list below are also not permitted.
2. Students may not use the following materials during exams. Any materials that are not mentioned in the list below are also not permitted.
||Introduction to Financial Engineering
||Ch. 1 and 2
| Week 2
||Capital Markets Overview
| Week 3
||Corporate Finance & Valuation
| Week 4
| Week 5
||Fixed Income Debt Securities
| Week 6
||Overview of Bonds Sectors & Instruments
| Week 7
||Valuation of Debt Securities
| Week 8
| Week 9
||Leveraged Loans & CLO's
| Week 10
||General Principles of Credit Analysis
| Week 11
| Week 12
||Poisson Processes and Jump Diffusion
| Week 13
| Week 14
||Review & Catch-up