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Management

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Risk Management & Insurance
Exam 1

By
Gursharan Deep Singh

T.Engel
MBA 546
Oct11 2013

Q1-We have studies how firms evaluate various risks and risk management techniques. Identify the risks and describe the techniques?
Answer- Risk has been defined as uncertainty concerning the occurrence of loss.

Various types of risk faced by firms are as follow:

1.property risks: The risk of damage to business property due to natural disasters like flood, earthquake. Tornadoes, fires and other perils.
2.Liability risks: In this company is sued for numerous number of reasons such as injuries to customer, discrimination against employees.
3.pure and speculative risk: pure risk is defined as situation in which there are only the possibilities of loss or no loss.
Speculative is the one in which there is either profit or loss is possible.
4.stratergic risk: A possible source of loss that might arise from the pursuit of an unsuccessful business plan. For example, strategic risk might arise from making poor business decisions, from the substandard execution of decisions, from inadequate resource allocation, or from a failure to respond well to changes in the business environment.
5.operational risk: Probability of loss occurring from the internal inadequacies of a firm or a breakdown in its controls, operations, or procedures.
6.financial risk: The probability of loss inherent in financing methods which may impair the ability to provide adequate return.
7. Transaction: Assets relocation of mergers and acquisitions, spin-offs, alliances and joint ventures.
8.Investor Relations: Strategy for communicating with individuals who have invested in the business.
9.Compliance Risk (Legal Risk): These are risks associated with the need to comply with the rules and regulations of the government.
10.Other risks: These include crime exposures, Human resource exposures, foreign loss exposures, intangible loss exposures.
Various techniques used by firms to evaluate risk-
1.Avoidance: or e.g. we can avoid taking business in high crime rate area.
2.loss control: loss control includes various activities that reduce risk. Activities have two major objectives: * Loss prevention: for e.g. auto accidents can be reduced by taking safe driving course. * Loss reduction: for e.g.-department store can install sprinkler system to reduce severity of loss.
3.Retention: It means business or individual retains part of all financial consequences of given risk.
4.Self-insurance: Another name of it is self funding, it is special form of planned retention in which part or all of given loss exposure is retained by the firm.
5.Non-insurance transfers- In this risk is transferred to party other than insurance company.
Methods of transferring risk are as follow: * Transfer of risks by contracts * Hedging price risks * Incorporation of business firm

Q2-what do you understand by integrated risk management? Answer-Integrated risk management is the integration of the management of risk at each level of management into all business and strategic planning and decision-making processes.
Integrated risk management brings together all risks that impact on each level of management. It means: * Making staff identify the likelihood and consequences of activities * Finding risks that impact on strategic and operational outcomes * Making decisions about the best way to achieve objectives * Targeting resources appropriately towards high-rating risks
The purpose of the Integrated Risk Management Framework is to: * Provide guidance to advance the use of a more corporate and systematic approach to risk management; * Contribute to building a risk-smart workforce and environment to protect the public interest, maintain public trust, and ensure due diligence; and * Propose a set of risk management practices that departments can adapt to their specific circumstances and mandate.

Q3-Caerfully and critically evaluate the progress of the implementation of the Dodd-Frank Act?
Answer: The Commission has proposed or adopted following rules in connection with the Dodd-Frank Act. That Act contains more than 90 provisions that require SEC rulemaking, and dozens of other provisions that give the SEC discretionary rulemaking authority. Of the mandatory rulemaking provisions, the SEC has proposed or adopted rules for more than three-quarters.
The Commission has put in place a foundation for a framework that will * support an entirely new regulatory regime designed to bring greater transparency and access to the securities-based swaps market, * adopted rules that will result in increased oversight and transparency around hedge fund and other private fund advisers gave investors a say-on-pay regarding executive compensation and established a whistleblower program which offers incentives for individuals with information regarding securities law violations to come forward. * The SEC also has proposed a series of rules designed to improve the practices of credit rating agencies, including rules to limit the conflicts that may arise when NRSROs rely on client payments to drive profits and rules to monitor rating agency employees who move to new positions with rated entities. When the Commission proposes or adopts a set of rules, often those rules are contained in a single document, called a 'proposing release' or an 'adopting release.
Q4: Evaluate the validity and usefulness of EMH? Answer: The hypothesis that prices of securities fully reflect available information about securities is called EMH. An investment theory states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. It is impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments.

The implication is that it is still a useful descriptive tool. The efficient markets hypothesis has come under heavy attack in the last couple of years. For defenders of EMH, the fallback position appears to be that, even though the theory may not be technically correct, it is the best approximation of market behavior. EMH says that stock prices are right—not in some absolute metaphysical sense, but at least in that they represent society’s best guess based on available information. Behavioral finance scholars point out, however, that there are ubiquitous limits to arbitrage that stand in the way of the market reaching this happy equilibrium.
Q5-Identify and explain causes and consequences of the 2007-2008 bubble ? Answer-The historical perspective on the decades leading up to the financial crisis shows that the global economy was by no means as stable as suggested by many observers. The crisis was largely unexpected and due to its complex roots, it continued to puzzle policymakers, economists and other commentators. The collapse in the real economy has had devastating consequences for households as a result of rising unemployment and surging poverty. At the same time, some countries have been affected more than others due to differences in initial conditions (state of economy, labour market, fiscal space, institutional framework) and exposure to direct and indirect impact of the crisis via credit and trade channels.
Rates, risk, regulations and global imbalances: factors behind the global financial crisis. Leading up to the crisis there were many telltale signs that should have set off alarm bells. The vast majority of academics, officials and investors ignored the signals and rather made profuse claims about a new era. The causes of the crisis have become, understandably, a major topic of discourse among both academics and policymakers. This puts one of the core tenets of capitalism into question. At the same time, most contributions to the ongoing post-mortem analysis of the crisis recognizes that government failure has played a major role in allowing banks and other financial institutions to capitalize on loop-holes in the regulatory system to increase leverage and returns. In terms of government policy, Taylor (2009) stresses that the excessively loose US monetary policy fuelled the credit boom, while others such as Elmendorf (2007) conclude that interest rates were not too low. The United States was the epicenter of the crisis and its economy was hit directly by the meltdown in the sub-prime mortgage market along with the repercussions of the financial crisis and the ensuing credit crunch. As a consequence, the United States economy fell into recession in December 2007 and is estimated to have shrunk by 2.7 per cent in 2009.However, this contraction is smaller than most G20 countries and smaller than the average for advanced economies This downturn may be the worst since World War II, the ensuing impact of the crisis on economies across the globe has been by no means the same. Indeed, diversity is a hallmark of the Great Recession of 2008-2009. Since the United States went into recession at the end of 2007, most advanced economies have joined the ranks, particularly those exposed through financial and later trade channels. But, at the same time, others, particularly in the Asia region (namely China and India but also Australia), have avoided a major contraction, despite their integration with the global economy. A number of low-income countries such as Ethiopia and Uganda also continue to grow strongly despite the downturn.

Q6-Has financial theory regarding risk kept pace with recent events? Answer- While the modern financial system evolved, regulation did not keep pace and became mismatched with the risks building in the economy. Government housing policies, over-regulation, failed regulation and deregulation have all been claimed as causes of the crisis, along with many others.
The theories made are right but the implementation of the theory at the right place is the main issue.
Q7- Identify and risks and potential benefits of current monetary policy? Answer-Monetary policy are actions taken by central banks, such as the Federal Reserve in the United States, the Bank of England and Australia, to affect the money supply and the overall efficiency of their respective nations' economies. Central banks use short-term interest rates, government securities and banking reserve requirements to affect the availability of money and credit in the economy. On September 13, 2012, the Fed announced a new round of asset purchases, pledging to purchase $40 billion GSE mortgage-backed securities per month until the labor market improves, as long as price stability is maintained. Coupled with $45 billion in monthly purchases of Treasury securities, the Fed’s balance sheet is now increasing by about $85 billion each month.
3 tools to influence the supply of money: * Adjust the required reserve ratio * Open market operations * Adjust the discount rate

Risks of current Monetary policy * Bubbles in high yield bonds and farm land and federal budgets. * Distortion in economy and difficulty pricing risks. * 1% interest rate on treasury bills i.e. 1 billion deficit to federal budget. * Savers and retirees take risks to get some sought of yield. * Federal reserve itself has large number of risks.

In the short run, an expansionary monetary policy that reduces interest rates increases interest-sensitive spending, all else equal. Interest-sensitive spending includes * physical investment (i.e., plant and equipment) by firms * residential investment (housing construction) * consumer-durable spending (e.g., automobiles and appliances) by households. * it also encourages exchange rate depreciation that causes exports to rise and imports to fall, all else equal. To reduce spending in the economy, the Fed raises interest rates, and the process works in reverse.
U.S. economic history will show that money- and credit-induced demand expansions can have a positive effect on U.S. GDP growth and total employment. The extent to which greater interest-sensitive spending results in an increase in overall spending in the economy in the short run will depend in part on how close the economy is to full employment. When the economy is near full employment, the increase in spending is likely to be dissipated through higher inflation more quickly.

Q8-Explain how current fiscal/budgetary issues in Washington are affecting business decisions? Answer-Due to the shutdown of government i.e. budget has not been passed many of the employees of government haven’t got their pay. My opinion is that if the government employees will not get their pay at proper time whole of the family will have to suffer as the family member has to look for another job to enjoy the same living standard and if he or she doesn’t get another job he or she has to reduce his or her expenses i.e. purchasing power of person becomes less due to which business firms have to raise their price in order to run their business i.e. inflation Considering the length of shutdown we will be in better position to tell the consequences if it carries for long time. The partial government shutdown is now in its eleventh day and less than remains before october17 deadline to extend government borrowing authority. For e.g. if the family has income of 15 thousand dollars and now they are getting only 6 thousand dollars a month, they have to make financial decision which will indirectly affect all the business firms a lot as they have only 6 thousands to spend out of which they have to make savings also. For e.g. JP Morgan, the biggest U.S bank by assets reported a rare quarterly loss after incurring $9.2billion in legal expense. Excluding litigation expense and reserve release, it earned a profit of $5.82 billion or $1.42 a share. Secondly, MU.O fell 3 percent to $17.88

References http://www.pimco.com/EN/Insights/Pages/Hyperactive-Monetary-Policy-The-Good-the-Bad-and-the-Ugly.aspx http://en.wikipedia.org/wiki/Monetary_policy http://www.ehow.com/info_8239910_advantages-disadvantages-monetary-policy.html?ref=Track2&utm_source=ask http://www.nytimes.com/interactive/us/politics/debt-reckoning.html?_r=0 http://topics.nytimes.com/top/reference/timestopics/subjects/f/federal_budget_us/index.html http://en.wikipedia.org/wiki/Efficient-market_hypothesis#Criticism_and_behavioral_finance

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