The document discusses financial risk management. It defines three main sources of financial risk: market risk, credit risk, and liquidity risk. It then provides details on specific types of market risk, including equity price risk, interest rate risk, foreign exchange risk, and commodity price risk. It also discusses how diversification across different asset classes can help reduce overall portfolio risk through lowering specific risk, though not systematic risk. The beta factor is introduced as a measure of an asset's systematic risk relative to the overall market.

1. Risk Management
University of Economics, Kraków, 2012
Tomasz Aleksandrowicz

2. financial risk management
financial risks types

3. sources of financial risks
• organization’s exposure to changes in market prices, such as
interest rates, exchange rates, and commodity prices
• 2. Financial risks arising from the actions of, and transactions
with, other organizations such as vendors, customers, and
counterparties in derivatives transactions
• 3. Financial risks resulting from internal actions or failures of
the organization, particularly people, processes, and systems

4. financial risk overview
• market risks
– equity price risk
– interest rate risk
– foreign exchange risk
– commodity price risk
• credit risk
– transaction risk
– portfolio concentration risk
• liquidity risk
– `funding liquidity risk
– asset liquidity risk

5. market risk
equity price risk
interest rate risk
foreign exchange risk
commodity price risk

6. equity price risk
• risk resulting from holding equities or assets with
performance tied to equity prices
• faced by all organizations possessing or issuing
equities

7. interest rate risk
• risk resulting from volatility of interest rates
• faced by all companies with borrowings (affecting
cost of funds)
– loan with fixed rate of interest
– loan with floating (variable) rate of interest
• impact depends on company structure / relation of:
– capital and debt (leverage ratio)
– short and long term debt
– fixed and floating rate debt

8. foreign exchange rate risk
• risk resulting from change in the exchange rate of
one currency against another
• faced by all organizations involved in foreign
exchange or utilizing commodities denominated in
other currency

9. commodity price risk
• risk resulting from commodity prices rising or falling
• faced by all organizations that produce or purchase
commodities

10. derivatives

12. Portfolio creation approach
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13. diversification (I)
• diversification means reducing risk by investing in a variety of
assets
• it means: don't put all your eggs in one basket
• diversified portfolio will have less risk than the weighted
average risk of its elements
• often less risk than the least risky of its parts
• crucial element is selection of assets with low correlation
• correlaton values:[-1,1]
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14. two assets portfolio
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15. two assets portfolio
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16. divrsification (II)
• specific risk and systematic risk
• individual, specific securities are much more risky than the
market
• specific risk can be lowered by diversification
• systematic risk is a limit for diversification efficiency – can not
be elimitnated by diversification
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17. Diversification (III)
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18. Asset specific risk – variance / sd
• specicfic risk could be measured by variance and standard
deviation of the asset
• sd and var how far a set of numbers are spread out from each
other (from mean/expected value)
• variance:
• standard deviation (sq root ov variance):
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19. Assets historical return and sd
Based on annual returns from 1926-2004
Avg. Return Std Dev.
Small Stocks 17.5% 33.1%
Large Co. Stocks 12.4% 20.3%
L-T Corp Bonds 6.2% 8.6%
L-T Govt. Bonds 5.8% 9.3%
U.S. T-Bills 3.8% 3.1%
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20. Asset systematic risk - beta factor
• systematic risk can be measured as the sensitivity of a stock’s return to
fluctuations in returns on the market portfolio
• the systematic risk is measured by the beta coefficient, or β.
• variation in asset/portfolio return depends on return of market portfolio
% change in asset return
b= % change in market return
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21. Beta Factor Interpretation
• if b = 0
– asset is risk free
• if b = 1
– asset return = market return
• if b > 1
– asset is riskier than market index
 if b < 1
– asset is less risky than market index
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22. Beta Factor Sample (5 yr)
Stock Beta
Amazon 3.30
DellComputer 2.14
GE 1.18
Ford 1.05
Delta Airlines 1.00
PepsiCo .67
McDonald's .66
Pfizer .57
ExxonMobil .41
H.J.Heinz .31
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