Course Objective

This is a course on how corporations make use of the insights and tools of risk management. Most courses on derivatives, futures and options, and financial engineering are taught from the viewpoint of investment bankers and traders in the securities. This course is taught from the point of view of the manufacturing corporation, the utility, the software firm — any potential end-user of derivatives, but not the dealer. Most related courses focus on the extensive taxonomy of instruments and the complex models developed to price them, and on ways to exploit mispricing. While this course will make use of some of these pricing models, the focus is on how corporations use the insights and models to improve their operations, to increase the value of their real assets, or to create the financial flexibility necessary to implement their core strategy.

There are many types of risk management going on in different parts of a company at the same time. The most familiar loci of risk management is trading operations and the treasury office. But many other parts of the firm are involved in risk management. The marketing department designs types of contracts for customers that share risk. Business unit managers evaluate projects with different risk characteristics, and decide on ways to alter projects so as to minimize risk without sacrificing return. The tax, legal and accounting departments are concerned with risk, with hedging and with the corporate governance issues. At the highest level of the company, key questions about the firm's strategy and its ability to fund its operations must be answered with an eye on the risks of each alternative and strategic decisions that can secure the greatest value for shareholders.

Each of these different risk management activities focuses on different aspects of risk management. The problem before a commodity trader is not the same problem that is before the business unit manager.

Topic Outline

The course will be organized according to the following outline of topics. Due to the short nature of the course, the depth into which each is explored will vary greatly. However, the outline is very useful for organizing the thinking about the place of risk management in the firm's business.

The Role of Risk Management

1. How Companies Manage Risk

2. How the Market for Risk is Organized

3. Why Manage Risk

The Tools of Risk Management

4. Measuring Risk

5. Instruments for Hedging

6. Pricing Risk

The Business of Risk Management

7. Valuation, Pricing and Investments

8. Asset Management

9. Trading Operations

10. Transaction Hedging

11. Liability Management

12. Strategic Hedging

13. Taxes

The Risk Management Function

14. Accounting

15. Organization, Governance and Control


From the corporate finance side, this course builds on material developed in 15.434, Advanced Corporate Finance. From the risk management side, this course builds on the tools and techniques developed in 15.437, Options and Futures Markets.

Course Format

The course will be taught with a mixture of lectures presenting specific tools and outlines of corporate problems and case discussions in which students attempt to apply the tools and concepts. The first segment of each meeting will be case discussion. Class participation is obviously critical. The second segment will be a lecture presentation with plenty of time for questions, discussion and interaction. The course is offered only on a Pass/Fail basis. A passing grade is earned by (1) minimum attendance, (2) general class participation, especially in the case analysis, and (3) obvious effort and accomplishment in mastering the basic tools. Engagement is the key. The learning is a collective process accomplished with involvement on the part of all.