Although everything sounds good with the current stimulus plan, just how long will the long-term effects catch back up to us. This plan could be prolonging the future economic pain.
According to the Washington Post, the Obama administration is seeking ways to reduce the number of foreclosures and spur demand as the housing recession enters its fourth year. Part of the plan calls for the federal government to match reductions that lenders would make in interest rates aimed at lowering borrowers' payments to 31 percent of their monthly income.
Last week, Obama also signed a stimulus package including an $8,000 tax-credit for first-time homebuyers. If this plan is aimed at primarily at graduating college students, then it might not be as effective due to the current job market. People might also see this tax credit as a way to get a bigger house than they had originally planned. Then if they cannot afford the payment then the whole housing crisis will start all over again.
Also since there is so much uncertainty in the job market people are shying away from buying houses and cars. Without job security they may not be able to make future payments.
We are relying too heavily on the government to get us out of this financial crisis. By trying to stimulate the economy, they could incur greater costs than they had expected. They could also hurt unintended markets and cause serious long-term damage. The government is absorbing too much cost, and won’t have an immediate way to finance them. The costs outweigh the benefits, and will cause the US to slip as being a major world power. Just how can we survive, when the government cannot operate without incurring a loss.
As of Feb. 22, 2009 the current outstanding public debt is $10.8 trillion. The estimated population is 305.7 million, which gives each citizen $35,370.19 in national debt that they haven’t directly caused. Since September 28, 2007 the national debt has increased an average of $3.52 billion per day. So you could say that the stimulus is just pennies compared to our current national debt.
Links:
http://www.washingtonpost.com/wp-dyn/content/story/2009/02/20/ST2009022002635.html
http://www.brillig.com/debt_clock/
Sunday, February 22, 2009
GM success: Chevy Volt
GM’s future success primarily depends on the success of the Chevy Volt and the Camero.
The Volt is said to go on the market in late 2010, as a 2011 model year. Since conception GM has been working hard to develop a battery to power the car. Since this will be such a revolutionary car GM plans to sell the Volt at $30,000, but first versions might be $40,000. The battery will last the first 40 miles and then a gas generator will kick in, that can be driven 400 miles on a full tank of gas. This type of technology will save consumers money on gas in the long run. Thus, once more electric powered cars are on the road, the cost of gasoline will decline and lessen our dependence on foreign oil.
Since the Volt will be the first full electric car, it will boost GM’s image and customer appeal. Customers today want “green” products that will reduce pollution, and this car will affect driver’s daily impact. Having an electric engine, the car will not produce harmful fumes that escape into the atmosphere.
I haven’t heard of any other GM competitors trying to develop a concept like this. So in order for GM to emerge from bankruptcy it might be strategic for them to release the car for a few years, and then sell their design to its competitors. They should make a contract, so they will a get a percentage of the sales of the cars. Thus they will be profiting from their own sales and also making a small profit from its competitors. This portion of GM’s small profit could be put forth towards research and development for future models and consumer surveys, to develop the quality of their cars.
Links:
http://gm-volt.com/chevy-volt-faqs/
The Volt is said to go on the market in late 2010, as a 2011 model year. Since conception GM has been working hard to develop a battery to power the car. Since this will be such a revolutionary car GM plans to sell the Volt at $30,000, but first versions might be $40,000. The battery will last the first 40 miles and then a gas generator will kick in, that can be driven 400 miles on a full tank of gas. This type of technology will save consumers money on gas in the long run. Thus, once more electric powered cars are on the road, the cost of gasoline will decline and lessen our dependence on foreign oil.
Since the Volt will be the first full electric car, it will boost GM’s image and customer appeal. Customers today want “green” products that will reduce pollution, and this car will affect driver’s daily impact. Having an electric engine, the car will not produce harmful fumes that escape into the atmosphere.
I haven’t heard of any other GM competitors trying to develop a concept like this. So in order for GM to emerge from bankruptcy it might be strategic for them to release the car for a few years, and then sell their design to its competitors. They should make a contract, so they will a get a percentage of the sales of the cars. Thus they will be profiting from their own sales and also making a small profit from its competitors. This portion of GM’s small profit could be put forth towards research and development for future models and consumer surveys, to develop the quality of their cars.
Links:
http://gm-volt.com/chevy-volt-faqs/
Risk modeling
Perhaps one contributing factor to the current economic crisis is that the models used by risk managers and employees did not model the correct risk. With so many methods to model one thing, you could possibly get two different outcomes by using different models. Considering a continuous number of methods and probability distributions, there is a good chance that the model you are implementing does not match the distribution. Even though the choice of method depends significantly on the amount and type of historical data available, each method has its advantages and disadvantages. Each method also requires varying analytical skill and experience.
There are 3 broad categories of modeling methods presented by the CAS:
Methods based primarily on the analysis of historical data
Methods based on a combination of historical data and expert input
Methods based primarily on expert input
I believe that models that represent both historical data and expert input should be more accurate. You don’t always want to base assumptions on models, since they don’t always represent real life situations, and if they did we wouldn’t be in an economic crisis.
One process that falls into this category is stochastic processes. This process expresses the difference in the value of a variable at time t and the value one time period later (t+1). This process is probably one of the more accurate processes since its probabilities consider the past, but future probabilities depend on the present state. Thus, stochastic processes predict random change looking into the future. However, there could be thousands of possible outcomes, which may get complicated to decipher.
Links:
http://www.ucop.edu/riskmgt/erm/documents/overview.pdf
There are 3 broad categories of modeling methods presented by the CAS:
Methods based primarily on the analysis of historical data
Methods based on a combination of historical data and expert input
Methods based primarily on expert input
I believe that models that represent both historical data and expert input should be more accurate. You don’t always want to base assumptions on models, since they don’t always represent real life situations, and if they did we wouldn’t be in an economic crisis.
One process that falls into this category is stochastic processes. This process expresses the difference in the value of a variable at time t and the value one time period later (t+1). This process is probably one of the more accurate processes since its probabilities consider the past, but future probabilities depend on the present state. Thus, stochastic processes predict random change looking into the future. However, there could be thousands of possible outcomes, which may get complicated to decipher.
Links:
http://www.ucop.edu/riskmgt/erm/documents/overview.pdf
Sunday, February 15, 2009
Stimulus package
Before President Bush left office he had implemented a stimulus package that was supposed to soften the blow on the economy. He also gave stimulus checks to people in order to jump-start the economy.
Since then there has been little to no effect, as we can see from the current economy. Now President Obama wants to spend $787 billion to help soften the blow again. He also says “that things are going to get worse before they get better.” However this stimulus package could make things a lot worse. We could be spending millions of dollars that will never affect the economy. I believe that he should wait until everything settles down, before he implements such a large stimulus plan. Then he could accurately pinpoint what is wrong with the economy and how to fix it effectively. Rather than just prolong the situation and continue the same bad habits that got us into this mess, we should not rely on the government to solve this problem. After all when government gets involved in things they screw things up. Considering our growing national debt, just how much is too much, and when will the spending stop. It has been justified that since we stimulate other economies that being in debt constantly is ok. However, this debt has finally caught up with us. The government has crippled the nation, since we constantly borrow on credit from other nations.
Links:
http://www.nytimes.com/2009/02/16/us/politics/16talkshows.html?_r=1&hp
Since then there has been little to no effect, as we can see from the current economy. Now President Obama wants to spend $787 billion to help soften the blow again. He also says “that things are going to get worse before they get better.” However this stimulus package could make things a lot worse. We could be spending millions of dollars that will never affect the economy. I believe that he should wait until everything settles down, before he implements such a large stimulus plan. Then he could accurately pinpoint what is wrong with the economy and how to fix it effectively. Rather than just prolong the situation and continue the same bad habits that got us into this mess, we should not rely on the government to solve this problem. After all when government gets involved in things they screw things up. Considering our growing national debt, just how much is too much, and when will the spending stop. It has been justified that since we stimulate other economies that being in debt constantly is ok. However, this debt has finally caught up with us. The government has crippled the nation, since we constantly borrow on credit from other nations.
Links:
http://www.nytimes.com/2009/02/16/us/politics/16talkshows.html?_r=1&hp
Steroids in Baseball
Lately baseball has been to focused on records being broken, that it has failed to look back on those individuals achieved those records. Although you may attribute the increase in muscle mass to better technology and harder work ethics, there seems to be a fine line of natural and enhanced muscle development. There raises suspicion when a player gains 15-20 pounds in muscle in the off-season, roughly a 5-month period.
Back in the 1900’s when the game first began there were no performance enhancing drugs, and players didn’t play just for the money. To them it was a summer job, and they made nothing compared to today’s players. Now it seems like everyone is in it for the money, and not for the passion of the game.
In order to standout among the hundreds of players in the league, you need to put up above average numbers. This has produced so much pressure from players that they are willing to do anything to get a big contract, even if it means putting their own health at risk. In the era of Hank Aaron, there were probably very few players that had 40-50 homerun seasons. While today you cannot have a good year unless you have at least 30 homeruns.
With the recent investigation many of the star players in the 1990’s have been found to use performance-enhancing drugs in their career. With names like Arod, Clemens, Bonds, Tejada, Mcgwire, and Sosa it is hard to say that they would have accomplished what they did without enhancing drugs. This has tainted baseball’s image and will hurt future player’s reputations. Whenever someone breaks another record, they will have to answer the questions of whether it was legitimate or not. Ultimately the steroid era has produced illegitimate players, and has hurt baseballs reputation. There will be harsh long term effects, because people don’t want to pay money for cheaters to play the game. To correct this problem by engaging in risk management baseball needs to implement a harsher drug penalty, and test players on a regular basis. They also need to stay ahead of the latest new drugs that become available on the market.
Links:
ESPN
Back in the 1900’s when the game first began there were no performance enhancing drugs, and players didn’t play just for the money. To them it was a summer job, and they made nothing compared to today’s players. Now it seems like everyone is in it for the money, and not for the passion of the game.
In order to standout among the hundreds of players in the league, you need to put up above average numbers. This has produced so much pressure from players that they are willing to do anything to get a big contract, even if it means putting their own health at risk. In the era of Hank Aaron, there were probably very few players that had 40-50 homerun seasons. While today you cannot have a good year unless you have at least 30 homeruns.
With the recent investigation many of the star players in the 1990’s have been found to use performance-enhancing drugs in their career. With names like Arod, Clemens, Bonds, Tejada, Mcgwire, and Sosa it is hard to say that they would have accomplished what they did without enhancing drugs. This has tainted baseball’s image and will hurt future player’s reputations. Whenever someone breaks another record, they will have to answer the questions of whether it was legitimate or not. Ultimately the steroid era has produced illegitimate players, and has hurt baseballs reputation. There will be harsh long term effects, because people don’t want to pay money for cheaters to play the game. To correct this problem by engaging in risk management baseball needs to implement a harsher drug penalty, and test players on a regular basis. They also need to stay ahead of the latest new drugs that become available on the market.
Links:
ESPN
Saving General Motors
Perhaps one of America’s oldest businesses, General Motors is celebrating its 100th anniversary. However, it may be close to extinct within the following year without help from the government. Some argue that this is the first time that GM has asked the government for help in its 100-year history. Over the last few years GM’s market share has declined steadily. There is evidence that the CEO’s have repetitively lied, by saying that “things are going to get better.” Yet they almost always failed to keep their promises. In order for GM to survive another 100 years it needs to restructure its business plan, and to diversify their investments. Instead of only focusing on production of larger vehicles (SUVS), and many model options. This hurt them the last few years when oil prices were very volatile. They should follow the business models of its competitors, which have been more successful.
CNBC described GM as a house of cards, since it seems like they are all full of talk and don’t address issues to fix their business problems. For the last few years Honda and Toyota have been ahead of GM by introducing better technology to consumers faster. Over the last few years everyone had an electric car in the making, and Chevy has yet to introduce one that is better than its competitors. In 1993 they had an electric car in the making, but cut its development without reason.
Part of GM’s problem lies within its retirement plan. They have so much fixed cost tied up in retirement money, that they cannot achieve an adequate profit margin. They sometimes had to make a loss on a car to produce them. Then they would rely on the services that the dealership offered to make up on this loss. This might have worked if they had the most cars on the road in North America. This wasn’t the case, and they had produced negative earnings for a while. They have even bought out experienced workers, in efforts to reduce cost and hire less experienced workers. I feel that this will reduce the quality of their product, and cause them further problems.
Even though GM has its share of problems, some of its suppliers have directly depended on the success of this giant. If GM goes down, so do most of its suppliers. CNBC found that one small business provides a percentage of their work to GM, and the rest goes to other suppliers of GM. So if GM fails then it may affect hundreds of firms that supply GM with all of their parts.
Links:
CNBC Saving GM inside the crisis
http://www.nytimes.com/2008/11/12/business/12auto.html?_r=1&scp=5&sq=general%20motors%20bailout&st=cse
http://www.bloggingstocks.com/2007/07/31/general-motors-profits-again/
CNBC described GM as a house of cards, since it seems like they are all full of talk and don’t address issues to fix their business problems. For the last few years Honda and Toyota have been ahead of GM by introducing better technology to consumers faster. Over the last few years everyone had an electric car in the making, and Chevy has yet to introduce one that is better than its competitors. In 1993 they had an electric car in the making, but cut its development without reason.
Part of GM’s problem lies within its retirement plan. They have so much fixed cost tied up in retirement money, that they cannot achieve an adequate profit margin. They sometimes had to make a loss on a car to produce them. Then they would rely on the services that the dealership offered to make up on this loss. This might have worked if they had the most cars on the road in North America. This wasn’t the case, and they had produced negative earnings for a while. They have even bought out experienced workers, in efforts to reduce cost and hire less experienced workers. I feel that this will reduce the quality of their product, and cause them further problems.
Even though GM has its share of problems, some of its suppliers have directly depended on the success of this giant. If GM goes down, so do most of its suppliers. CNBC found that one small business provides a percentage of their work to GM, and the rest goes to other suppliers of GM. So if GM fails then it may affect hundreds of firms that supply GM with all of their parts.
Links:
CNBC Saving GM inside the crisis
http://www.nytimes.com/2008/11/12/business/12auto.html?_r=1&scp=5&sq=general%20motors%20bailout&st=cse
http://www.bloggingstocks.com/2007/07/31/general-motors-profits-again/
Sunday, February 8, 2009
Overview of ERM
This article was written by the CAS describing just about everything regarding ERM. The beginning of the article relates to what was on the first exam. They state that organizations have practiced ERM for a long time by prioritizing their risks. To counter their risks two common tools have been a transferred of risk or through financial tools.
With increasingly pure competition by means of globalization, ERM may become more important than ever before to companies. This may also contribute to companies facing more complicated risks that may be impossible to hedge against. Risks that are relatively new may not have enough people to insure to adequately pool their risks. Thus, the insurer would have to charge a percentile premium that could hurt the company if the insured incurred a catastrophic loss, since there are no past models to follow.
One of these new risks is exchange rate risk. This was one contributing factor to the failure of Enron and Barings Bank. The advancement in technology, accelerating pace of business, globalization, increasing financial sophistication and the uncertainty of irrational terrorist activity all contribute to the growing number and complexity of risks. These risks are anticipated to increase in the future.
With these increasing risks investors still want stable cash flows. To protect against such an event, a company could purchase some kind of earnings insurance that will make up the difference in expected income and actual income. If a company performs at a sub-par level, the insurance will make up for the difference in expected cash flows.
Links:http://www.ucop.edu/riskmgt/erm/documents/overview.pdf
With increasingly pure competition by means of globalization, ERM may become more important than ever before to companies. This may also contribute to companies facing more complicated risks that may be impossible to hedge against. Risks that are relatively new may not have enough people to insure to adequately pool their risks. Thus, the insurer would have to charge a percentile premium that could hurt the company if the insured incurred a catastrophic loss, since there are no past models to follow.
One of these new risks is exchange rate risk. This was one contributing factor to the failure of Enron and Barings Bank. The advancement in technology, accelerating pace of business, globalization, increasing financial sophistication and the uncertainty of irrational terrorist activity all contribute to the growing number and complexity of risks. These risks are anticipated to increase in the future.
With these increasing risks investors still want stable cash flows. To protect against such an event, a company could purchase some kind of earnings insurance that will make up the difference in expected income and actual income. If a company performs at a sub-par level, the insurance will make up for the difference in expected cash flows.
Links:http://www.ucop.edu/riskmgt/erm/documents/overview.pdf
Economy and stimulus plan
During campaigning President Obama said something along the lines that he wouldn’t let lobbyists control the agenda of Washington. Then he puts someone that’s a lobbyist on his cabinet.
Its sad that people the president nominates for a position has to withdrawal their nomination due to tax reasons. After all, aren’t our tax dollars contributing to their salaries.
This just proves that politicians aren’t the same as they used to be. Throughout school we learn about the great leaders and politicians that have built this country, and just how great they were. Now, all you hear about is how corrupt they are. It seems like they are just holding their seat for the title and fame, instead of acting in the best interest of the people that elect them.
Through the Bush era we were encouraged to spend. However now people are scared to because of the lack of stability in the economy. We have seen little effects to what the stimulus checks and first stimulus plan were set out to do. I’m not sure on how much money was injected into the economy, and the return from it. However, just how much longer can the government prolong this downfall. While they are living in luxury, thousands of people are losing their jobs daily. There is also a fine line on where to stop this stimulus plan. I’m sure we are already dealing with inflation from the war, and by putting $820 billion into the economy it will continue to grow.
President Obama seemed so confident that his plan would work before he was elected, but it been 2 weeks and there still hasn’t been any gains in reaching an agreement. Currently the House and the Senate are in debate over the contents of the stimulus package. The stimulus money from the House plan will go towards aiding state and local government, tax provisions, and education, health and renewable energy programs. Both plans are intended to blunt the recession with a combination of fast-acting tax cuts to help increase spending by consumers and businesses, and slower long-term government spending on public works projects and other programs to create more than 3 million jobs.
President Obama’s middle class tax cuts are intended to lift consumer spending and help jump-start the economy. Hopefully consumers have learned their lesson, by not over indulging and end up with more debt than they can handle. If this trend were to continue, the cycle will just prolong the recession and cause demand for a second wave of a stimulus package.
Whatever the final figure may be the plan needs to be very structured and not allow state and local governments slack to waste money. There is argument that only a small percentage of the stimulus money will directly impact the economy, and the rest is just thrown into the bill to satisfy old democratic promises.
Links:http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2009/02/07/MNEV15PJKT.DTL&type=politics
Its sad that people the president nominates for a position has to withdrawal their nomination due to tax reasons. After all, aren’t our tax dollars contributing to their salaries.
This just proves that politicians aren’t the same as they used to be. Throughout school we learn about the great leaders and politicians that have built this country, and just how great they were. Now, all you hear about is how corrupt they are. It seems like they are just holding their seat for the title and fame, instead of acting in the best interest of the people that elect them.
Through the Bush era we were encouraged to spend. However now people are scared to because of the lack of stability in the economy. We have seen little effects to what the stimulus checks and first stimulus plan were set out to do. I’m not sure on how much money was injected into the economy, and the return from it. However, just how much longer can the government prolong this downfall. While they are living in luxury, thousands of people are losing their jobs daily. There is also a fine line on where to stop this stimulus plan. I’m sure we are already dealing with inflation from the war, and by putting $820 billion into the economy it will continue to grow.
President Obama seemed so confident that his plan would work before he was elected, but it been 2 weeks and there still hasn’t been any gains in reaching an agreement. Currently the House and the Senate are in debate over the contents of the stimulus package. The stimulus money from the House plan will go towards aiding state and local government, tax provisions, and education, health and renewable energy programs. Both plans are intended to blunt the recession with a combination of fast-acting tax cuts to help increase spending by consumers and businesses, and slower long-term government spending on public works projects and other programs to create more than 3 million jobs.
President Obama’s middle class tax cuts are intended to lift consumer spending and help jump-start the economy. Hopefully consumers have learned their lesson, by not over indulging and end up with more debt than they can handle. If this trend were to continue, the cycle will just prolong the recession and cause demand for a second wave of a stimulus package.
Whatever the final figure may be the plan needs to be very structured and not allow state and local governments slack to waste money. There is argument that only a small percentage of the stimulus money will directly impact the economy, and the rest is just thrown into the bill to satisfy old democratic promises.
Links:http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2009/02/07/MNEV15PJKT.DTL&type=politics
Risk free rate and CAPM
From CAPM the risk free rate is probably the most second important factor. The bigger the difference in the risk premium the greater the expected return. Since the risk free rate changes constantly, you need to pay close attention in case the risk premium becomes negative. When this happens it is better to invest in a risk free asset such as a bond instead of taking a risk and potentially never regain your money. Just remember to buy low and sell high, to possibly see immediate gains from you investment.
E(Ri)= b(rm-rf)+rf
E(Ri)= b(rm-rf)+rf
Sunday, February 1, 2009
Guantanamo Bay
President Obama said that he will close Guantanamo Bay as soon as possible. However, is this message consistent with what George Bush implemented in his 8 years. Although US intelligence has not been 100% accurate lately, there is probably a good reason why they are holding these detainees that are extremely dangerous. Now there is a greater risk that acts of terrorism will be committed in the US and worldwide.
There is a concern that once released they will continue to engage in terrorism in the future. Before Obama took office there was a report that 18 former detainees are confirmed to have participated in attacks, and 43 are suspected to be involved is attacks. Once someone has engaged in activities and developed habits, it is hard for them to break them. I saw on the news that former detainees were being cleansed by coloring and drawing pictures. Just exactly how is this helping them not commit acts of terror.
What was the point of the “war on terror” when we are just going to release them and run off into the sunset? Just exactly what kind of message is this sending to the people fighting in Iraq, and to those that have lost their lives in the process. Why have we spent time to capture these people, and then just release them.
The main concern is that why all of a sudden we need to play God by sending a message to the rest of the world, while the terrorists the US are holding want to hurt our people and destroy our country. Why are we putting ourselves in a riskier situation. Since September 11, 2001 there have been no terrorist attacks on the US. With the release of the detainees we are now more vulnerable to attacks. This is a bad move on behalf of the president that will create more problems than rewards in the future. The president has enough to manage currently with the financial situation, and he does not need any more issues to complicate the matter.
As of yet there have been no economic decisions made by President Obama, while daily thousands of people are losing their jobs.
Links:
http://www.cnn.com/2009/POLITICS/01/26/gitmo.next/index.html?iref=newssearch
http://www.cnn.com/2009/POLITICS/01/28/obama.first.week/index.html?iref=newssearch
http://www.cnn.com/2009/POLITICS/01/28/US.Iran.change/index.html?iref=newssearch
There is a concern that once released they will continue to engage in terrorism in the future. Before Obama took office there was a report that 18 former detainees are confirmed to have participated in attacks, and 43 are suspected to be involved is attacks. Once someone has engaged in activities and developed habits, it is hard for them to break them. I saw on the news that former detainees were being cleansed by coloring and drawing pictures. Just exactly how is this helping them not commit acts of terror.
What was the point of the “war on terror” when we are just going to release them and run off into the sunset? Just exactly what kind of message is this sending to the people fighting in Iraq, and to those that have lost their lives in the process. Why have we spent time to capture these people, and then just release them.
The main concern is that why all of a sudden we need to play God by sending a message to the rest of the world, while the terrorists the US are holding want to hurt our people and destroy our country. Why are we putting ourselves in a riskier situation. Since September 11, 2001 there have been no terrorist attacks on the US. With the release of the detainees we are now more vulnerable to attacks. This is a bad move on behalf of the president that will create more problems than rewards in the future. The president has enough to manage currently with the financial situation, and he does not need any more issues to complicate the matter.
As of yet there have been no economic decisions made by President Obama, while daily thousands of people are losing their jobs.
Links:
http://www.cnn.com/2009/POLITICS/01/26/gitmo.next/index.html?iref=newssearch
http://www.cnn.com/2009/POLITICS/01/28/obama.first.week/index.html?iref=newssearch
http://www.cnn.com/2009/POLITICS/01/28/US.Iran.change/index.html?iref=newssearch
Risk pooling and life insurance.
When you pool risk then the probability for everyone in that pool to incur higher losses decreases. Also when you have about 20 or more people in the pool, the distribution of the losses becomes normal. So the more people you add the closer you get to a true normal distribution. Also, as you add more people the mean might increase a little but the standard deviation will decrease. This will create a slimmer normal distribution (with different size and scale parameters), that have most of the losses occurring around the mean, and a smaller probability of being in the tail.
From the central limit theorem:
E(Xi) = n*E(X)
Var(Xi)= n*Var(X)
You then use the new variance and the expected value from a given distribution to standardize the distribution into a normal distribution. Then you can use the Z score table to find percentiles that you are interested in.
Z=(X-E(X))/standard deviation
From the central limit theorem:
E(Xi) = n*E(X)
Var(Xi)= n*Var(X)
You then use the new variance and the expected value from a given distribution to standardize the distribution into a normal distribution. Then you can use the Z score table to find percentiles that you are interested in.
Z=(X-E(X))/standard deviation
Why does it make sense for a company to purchase insurance or to hedge its risks?
A company should do whatever strategy that will minimize its risk at the lowest cost. If a company hedges its risks through the stock market or by options, it will constantly have to rebalance its portfolio daily. Each time they do this they would pay transaction costs. Most of the time you hedge to prevent against price increases in the market. Not all of hedging is preventable by means of the stock market. Depending on what you are hedging against then it may be necessary to buy some type of insurance. For example if you want to protect yourself from a fire loss then you would buy fire insurance, because there are no financial instruments that will protect you from a fire loss.
If hedging reduces diversifiable risk, then hedging will not reduce the opportunity cost of capital. Hedging and insurance reduce systematic risk (nondiversifiable risk) will reduce the opportunity cost of capital.
When a company purchases insurance they pay a premium, which consists of the expected loss that the insurer calculates plus some loading. Since the company already expects to lose the calculated expected loss there is no need for the company to pay for the additional cost of loading. However through the purchase the company buys the insurer’s services that may save the company time, money, and aggravation. Insurance benefits you the most when you actually do have a really big loss.
If hedging reduces diversifiable risk, then hedging will not reduce the opportunity cost of capital. Hedging and insurance reduce systematic risk (nondiversifiable risk) will reduce the opportunity cost of capital.
When a company purchases insurance they pay a premium, which consists of the expected loss that the insurer calculates plus some loading. Since the company already expects to lose the calculated expected loss there is no need for the company to pay for the additional cost of loading. However through the purchase the company buys the insurer’s services that may save the company time, money, and aggravation. Insurance benefits you the most when you actually do have a really big loss.
How does the risk premium reflect beta?
From the equation E(ri)=beta*(rm-rf) + rf , the expected return on any stock, the rick premium is the quantity (rm-rf). So, if the risk premium is small changes in beta become insignificant. Since you are multiplying beta by a really small number close to zero, then beta*(rm-rf) goes to zero, and you are left with the risk free rate.
The opposite is true for large risk premium. The larger the risk premium, the closer you get to beta. This will result in a higher expected return. The risk premium only depends on nondiversifiable risks, which include market and systematic risk.
The opposite is true for large risk premium. The larger the risk premium, the closer you get to beta. This will result in a higher expected return. The risk premium only depends on nondiversifiable risks, which include market and systematic risk.
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