1. Market Efficiency vs Risk Taking
    Firms may not necessarily have to hedge add'l risk from trying to beat the mkt as it will naturally be diversifiable by the SH
  2. 3 examples of costs that can be reduced through risk mgmt
    • Reduce bankruptcy costs
    • Reduce payments to stakeholders
    • Reduce taxes
  3. Primary objective of risks mgmt
    Eliminate costly lower tail outcomes, thereby minimizing the likelihood of financial distress and preserving the financial ability to carry out their investment objectives
  4. Risks management in practice
    • Larger firms hedge more than small firms
    • Firms often engage in selective hedging (allow their views of mkt to influence hedging decision)
    • Firms hedge on a transactional basis
    • Shy away from giving up gains to avoid losses
  5. 3 special cases of capital structure strategies
    • Highly rated firm w/ low debt to equity ratio: instead of not hedging could incr debt equity ratio to take adv of debt (taxes, etc.)
    • Firm w/ low credit rating and significant prob of financial distress: engage in active risk management
    • Firm in distress: should not hedge because most gains will go to debtholders anyway. Take higher risk to seek for higher return, because if loss, borne by debtholders
  6. VaR vs longer time horizon
    • Need massive historical data, so the larger the horizon the less data available
    • Assumes a normal dist but long term have fatter tail
  7. Cash Flow Simulation as an alternative to VaR
    • Allows to measure risk over longer time horizon
    • Studies path of firm, not just end result
    • Allows for non-normal dist
  8. Managing risk taking
    • Gains from risky activities must be measured on a risk-adjusted basis
    • Compensation systems should be desgined so that managers are compensated only for earning xs risk-adjusted returns, not just for taking risk
Card Set