Summing up and what next?
Over the last four weeks we’ve had a look at many components of risk management.
We started Week 1 by considering investors and financial and non-financial institutions, and the kinds of risk they experience and are required to manage.
- We examined how financial markets work, and how they adapt as technologies and habits evolve.
- We then discussed the returns and risk associated with financial assets, and in particular, bonds and equities.
- We concluded Week 1 by considering different types of risk: unsystematic risk (also known as idiosyncratic risk) that can be diversified away; systematic risk that cannot be diversified; and systemic risk, which is the risk that financial markets cease to function.
In Week 2 we started to examine in more detail how to measure and manage the risk associated with financial securities.
- We considered the expected return and risk of portfolios of financial securities, and examined how to use diversification to reduce the risk of a portfolio.
- We saw how the effect of each security on the risk of the overall portfolio depends not only on the risk of the individual security, but also on how the return on the security varies in relation to the returns on the other securities in the portfolio.
- To examine this interrelationship further, we considered the capital asset pricing model and the beta of a company, which is a useful summary measure of how the return on the stock of a company varies in relation to the return on the market. Models such as the CAPM are based on assumptions concerning the way markets work and investors make decisions.
- We considered how investors might make decisions in ways that do not match these assumptions.
- We also examined the principles of Islamic finance, and the ways in which Islamic finance offers an alternative perspective on how risk can be managed.
In Week 3 we examined the characteristics of forwards, futures and options, and how to use them to manage risk.
- We examined in detail the payoffs from call options (involving the right to purchase an underlying asset) and put options (involving the right to sell an underlying asset), the circumstances when options have value, and how to price these derivatives.
In Week 4 we considered more of the tools used to measure and manage risk.
- We examined how to compute and interpret Value-at-Risk, and assessed the application of this approach.
- We also considered the yield curve, which shows the returns on bonds for a range of maturities, from short to long, and what the yield curve indicates about expected future developments in financial markets and the economy.
- Finally in Week 4 we discussed the challenges and opportunities presented by risk management, and how firms use risk management in practice.
You can distinguish specific from systemic risk. You can diversify your investments between umbrellas and ice-cream. You know your futures from your forwards. And if anyone mentions Value-at-Risk, you know to ask about thick tails.
With the help of other learners, we hope you have come to better appreciate the complexities in managing risk, and you can see how firms apply the principles of risk management to control their own risk; how financial companies manage portfolios of investments; and how complex financial institutions disperse and manage risk in an increasingly challenging and connected world. The global economic and political environment is ever-changing, and we encourage you to keep your eye on the financial news to apply what you have learnt, and to see how these challenges play out.
Above all, we would like to thank you for participating in the course. We hope you enjoyed it.