Course ReviewCurrent State of Financial Risk ManagementOperational and Strategic Risk AnalyticsSolvency Related Risk MeasuresPerformance Related Risk MeasuresConclusionAcknowledgementsIn This Course You Should Have Learned How to:Combined Final ExamFinal Exam DetailsTest Taking AdviceExam Topics Include - 1Exam Topics Include - 2Exam Topics Include - 3Exam Topics Include - 4Exam Topics Include - 5Exam Topics Include - 6Exam Topics Include - 7Sample QuestionSlide 20Slide 21Slide 22Slide 23Slide 24Slide 25Slide 26Slide 27Slide 28Slide 29Slide 30Slide 31Pre-Exam Office Hours 311 Wohlers HallCourse Review•Complete ERM lecture•What you should have learned from this class•Final exam details•Sample exam questionsCurrent State of Financial Risk Management •Modeling is used extensively in measuring market risk•Interest rate sensitivity measures depend on cash flow models and term structure models•Value-at-Risk measures also depend on models•Don’t be fooled by indicated precision of measures•Understand the models underlying the calculationsOperational and Strategic Risk Analytics•Analytic methods are primitive •Top-Down Approaches–Analogs•Remove identifiable risks first•Remaining risk is classified as operational risk–Historical loss data•Bottom-Up Approaches–Self assessment–Cash flow modelSolvency Related Risk Measures•Probability of Ruin•Shortfall Risk•Value-at-Risk (VaR)•Expected Policyholder Deficit (EPD) or Economic Cost of Ruin (ECOR)•Tail Value at Risk (Tail VaR) or Tail Conditional Expectation (TCE)•Tail EventsPerformance Related Risk Measures•Variance•Standard Deviation•Semi-variance and Downside Standard Deviation•Below-target-risk (BTW)Conclusion•There is a standard approach for dealing with each type of risk•Each area has its own terminology and techniques•The ERM challenge is to combine these different approaches into a common method that can deal with risk in an integrated manner •The first step is to understand the different approachesAcknowledgements•Frank Strenk, Lockton Companies•James Lam•Mark Vonnahme, Department of Finance, U of IIn This Course You Should Have Learned How to:•Analyze the financial condition of a corporation•Calculate the cost of capital for a project•Recognize the various ways the risk of the project can be altered•Determine whether a corporation should invest in a project •Compare debt, equity and alternative financing approaches•Explain how a particular project should be structured and fundedCombined Final ExamBoth 8:30 am and 10 am sectionsFriday, May 4, 2007 8-11 am120 Architecture BuildingConflict exam 8-11 am Monday, May 7115 DKHYou have to let me know by today if you want to take the conflict exam and explain why(See signup sheet)Final Exam Details•Exam is open book, open note.•You may use calculators, including financial calculators, but not laptops, cell phones or any other communication devices.•Test covers material from the entire semester, including guest speakers and student presentations, assignments 1-4 and all three cases.–Keys for assignment 4 will be posted today (5/1)•Exam tests your ability to make informed corporate finance decisions, perform financial calculations and to explain corporate finance concepts.Test Taking Advice•First answer all the questions you can without relying extensively on your notes.•Then work on the remaining questions if time permits.Exam Topics Include - 1•Corporations•Roles and Titles of Financial Managers•Principal-Agent Problems•Financial Statements–Balance Sheet (Figure 29.1)–Income Statement (Figure 29.2)–Sources and Uses of Funds (Figure 29.3) •Measuring a Firm’s Financial Condition•Key Financial Ratios•Financial Planning•Introduction to Present Value•Objectives of the Firm•Corporate GovernanceExam Topics Include - 2•Calculations–Valuing Assets–Perpetuities and Annuities–Compound Interest–Nominal and Real Interest Rates•Bond Valuation•Stock Valuation•How Common Stocks are Traded•Estimating the Cost of Equity Capital•Linking Stock Price and Earnings per Share•Net Present Value•Internal Rate of Return•Alternative Investment Decision RulesExam Topics Include - 3•Capital Asset Pricing Model•What Discount Rate to Use•Risk and Return•The Market Risk Premium•Capital Asset Pricing Model Considerations•Determining Beta•Arbitrage Pricing Model•Certainty Equivalents•Why Manage Diversifiable Risk?•Types of Risk•Traditional Approach to Risk Management•Enterprise Risk ManagementExam Topics Include - 4•Sensitivity Analysis•Scenario Analysis•Monte Carlo Simulation•Real Options•Decision Trees•Market Values•Economic Rents and Competitive Advantage•Warren Buffet on Growth and Profitability•Sources of Funds for Corporate Financing–Internal financing–Stock–DebtExam Topics Include - 5•How Corporations Issue Securities–Role of venture capital–IPOs–Private placements•Payout Policy–Dividends–Stock repurchases•Debt Policy–Modigliani and Miller propositions–WACC (before and after tax)•Why M&M Does Not Hold–Taxes–Financial distressExam Topics Include - 6•Theories of Capital Structure–Trade-off theory–Pecking order of financing choices•Financing and Valuation–After-tax WACC–Adjusted present value•Capital Investment Process–Agency problems–Monitoring–Incentives•Stock Options–Valuation–Appropriate and inappropriate usesExam Topics Include - 7•Integrating Capital and Risk –Insurative model–Total Average Cost of Capital•Enterprise Risk Management–Concept–Applications–VaRSample QuestionThe WACC for a firm is 10%.The after-tax WACC is 8.5%.The cost of debt is 8%.The cost of equity is 13%.The opportunity cost of capital for a project is 20%.The firm’s marginal tax rate is 35%.What is the appropriate interest rate to use to determine the NPV of this project if it will be financed entirely by debt?A) 5.0% D) 20%B) 8.5% E) None of the aboveC) 13.0%Increasing the corporate tax rate while leaving personal tax rates unchanged would have what effect on the value of leverage per $ of debt for a leveraged firm compared to an unlevered firm?A) IncreaseB) DecreaseC) No effectD) It depends on the relationship among the tax ratesE) None of the aboveWhat is the present value of the corporate tax shield if a firm plans to borrow $1 million for 1 year at an interest rate of 10% to invest