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Chapter 9: Risk Management and
Shareholders Wealth
The cost of risk
The principles of business valuation
Risk mgmt and the opportunity cost of capital
Risk mgmt and expected cash flows
An overview of tools used in corporate risk mgmt
Introducing Excel
Determining probability distribution parameter Using Monte Carlo
simulation to estimate
aggregate loss distribution
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The time, effort and hassle you spend on
Identifying, assessing and reducing risk
Securing quotes, analyzing quotes and purchasinginsurance
Attending to all of the insurance detail
The dollars you spend on
Insurance premiums
Deductible losses
Uninsured losses
More specifically, its
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Expected
loss
Cost of loss
control
Cost of loss
financing
Cost of
residual
uncertainty
Cost of risk
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(+)
=
magnitude
timing Risk
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Cost of capital, r
Risk Free
Rate
Rate of Return
that
compensates for
time value ofmoney because
of delaying
consumption
Risk PremiumRate of Return on assuming additional
risk
Diversifiable
Firm-specific-
Risk
Unsystematic
Non-
Diversifiable Market Risk
Systematic risk
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Cost Benefit Analysis
Accept Benefits are greater than cost
Reject Benefits are less than cost
Implement Risk Management
Minimizing the cost of risk
Marginal Cost = Marginal Benefit (Min)
Accept :: MB > MC
MarginalCost
Implement Risk Management Compute NPV
Maximizing Business Value
Accept:: NPV >0
Net presentvalue
Methodology:
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For explanation on Monte Carlo simulation:
http://www.palisade.com/risk/monte_carlo_simulation.asp
Demo on Monte Carlo using simple
Excel:https://www.youtube.com/watch?v=XOA0_X5yJHQ&feature=youtu
be_gdata_player
http://www.palisade.com/risk/monte_carlo_simulation.asphttps://www.youtube.com/watch?v=XOA0_X5yJHQ&feature=youtube_gdata_playerhttps://www.youtube.com/watch?v=XOA0_X5yJHQ&feature=youtube_gdata_playerhttps://www.youtube.com/watch?v=XOA0_X5yJHQ&feature=youtube_gdata_playerhttps://www.youtube.com/watch?v=XOA0_X5yJHQ&feature=youtube_gdata_playerhttp://www.palisade.com/risk/monte_carlo_simulation.asphttp://www.palisade.com/risk/monte_carlo_simulation.asp
