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Chapter 23 Web Extension

Chapter 23 Web Extension. Insurance and Bond Portfolio Risk Management. Topics. Risk identification and measurement Property loss, liability loss, and financial loss exposures Bond portfolio risk management. How are risk exposures identified and measured?.

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Chapter 23 Web Extension

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  1. Chapter 23 Web Extension Insurance and Bond Portfolio Risk Management

  2. Topics • Risk identification and measurement • Property loss, liability loss, and financial loss exposures • Bond portfolio risk management

  3. How are risk exposures identified and measured? • Large corporations have risk manage-ment personnel which have the responsibility to identify and measure risks facing the firm. • Checklists are used to identify risks. • Small firms can obtain risk manage-ment services from insurance companies or risk management consulting firms.

  4. Describe (1) “property” loss and(2) “liability” loss exposures. • Property loss exposures: Result from various perils which threaten a firm’s real and personal properties. • Physical perils: Natural events • Social perils: Related to human actions • Economic perils: Stem from external economic events

  5. Liability loss exposures: Result from penalties imposed when responsi-bilities are not met. • Bailee exposure: Risks associated with having temporary possession of another’s property while some service is being performed. (Cleaners ruin your new suit.) • Ownership exposure: Risks inherent in the ownership of property. (Customer is injured from fall in store.)

  6. Business operation exposure: Risks arising from business practices or operations. (Airline sued following crash.) • Professional liability exposure: Stems from the risks inherent in professions requiring advanced training and licensing. (Doctor sued when patient dies, or accounting firm sued for not detecting overstated profits.) (More…)

  7. What actions can companies taketo reduce property and liability exposures? • Both property and liability exposures can be accommodated by either self-insurance or passing the risk on to an insurance company. • The more risk passed on to an insurer, the higher the cost of the policy. Insurers like high deductibles, both to lower their losses and to reduce moral hazard.

  8. How can diversification reduce business risk? • By appropriately spreading business risk over several activities or operations, the firm can significantly reduce the impact of a single random event on corporate performance. • Examples: Geographic and product diversification.

  9. What is financial risk exposure? • Financial risk exposure refers to the risk inherent in the financial markets due to price fluctuations. • Example: A firm holds a portfolio of bonds, interest rates rise, and the value of the bonds falls.

  10. Financial risk management concepts • Duration: Average time to bondholders' receipt of cash flows, including interest and principal repayment. Duration is used to help assess interest rate and reinvestment rate risks. • Immunization: Process of selecting durations for bonds in a portfolio such that gains or losses from reinvestment exactly match gains or losses from price changes.

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