9780071546478

Summary

This comprehensive reference brings together ten of the world's leading scholars and practitioners, who provide invaluable perspectives on all aspects of finance theory and how they are applied to the process of risk management.The book begins with an overview of risk and risk aversion, introducing utility functions and the mean-variance criterion. It then delivers a thorough introduction to portfolio mathematics, including discussion of the efficient frontier, portfolio theory, and portfolio diversification.Written to help you fortify your defenses against extreme, unanticipated outcomes, and to ensure that returns are an adequate reward for risks taken,The Professional Risk Managers' Guide to Finance Theory and Applicationcovers key issues such as: The theory of capital allocation Capital structure, that is, debt versus equity financing The CAPM and multifactor models Interest rate models The term structure of interest rates No-arbitrage pricing of futures and forwards Risk-neutral valuation of optionsOffering a global view not found elsewhere,The Professional Risk Managers' Guide to Finance Theory and Applicationarms institutional investors, professional financial analysts and traders, auditors, corporate treasurers, regulators and actuaries with the practical tools to master any financial field.

Author Biography

The Professional Risk Managers' International Association (PRMIA) is one of the world's leading risk management associations, with over 40,000 members in 179 countries. A non-profit, PRMIA is dedicated to the development of new techniques and best practices for managing financial and investment risks, and offers the only globally endorsed Professional Risk Manager certification program.

Carol Alexander is Professor of Risk Management and Director of Research at the ICMA Centre, UK and Chair of the Academic Advisory Council of PRMIA.

Elizabeth Sheedy is an Associate Professor at the Macquarie Applied Finance Centre in Sydney, Australia.

About the Contributors	p. ix
Introduction: Interest Rates and Time Value	p. 1
Compounding Methods	p. 1
Interest Rates: Nominal, Periodic, Continuous, or Effective	p. 4
Risk and Risk Aversion	p. 7
Introduction	p. 7
Mathematical Expectations: Prices or Utilities?	p. 9
The Axiom of Independence of Choice	p. 10
Maximizing Expected Utility	p. 12
Encoding a Utility Function	p. 16
The Mean-Variance Criterion	p. 23
Risk-Adjusted Performance Measures	p. 26
Conclusions	p. 39
References	p. 41
Terminology	p. 42
Utility Functions	p. 44
Notes	p. 50
Portfolio Mathematics	p. 55
Means and Variances of Past Returns	p. 55
Mean and Variance of Future Returns	p. 65
Mean-Variance Tradeoffs	p. 72
Multiple Assets	p. 80
A Hedging Example	p. 84
Serial Correlation	p. 93
Normally Distributed Returns	p. 95
Reference	p. 102
Note	p. 102
Capital Allocation	p. 103
An Overview	p. 103
Mean-Variance Criterion	p. 109
Efficient Frontier: Two Risky Assets	p. 110
Asset Allocation	p. 114
Combining the Risk-Free Asset with Risky Assets	p. 116
The Market Portfolio and the Capital Market Line	p. 120
The Market Price of Risk and the Sharpe Ratio	p. 122
Separation Principle	p. 122
Conclusions	p. 123
Mathematics of the Mean-Variance Model	p. 125
The CAPM and Multifactor Models	p. 129
Overview	p. 130
Capital Asset Pricing Model	p. 131
Performance Measures	p. 136
The Single-Index Model	p. 139
Multifactor Models and the APT	p. 141
Conclusions	p. 143
References	p. 144
Notes	p. 144
Basics of Capital Structure	p. 147
Introduction	p. 147
Maximizing Shareholder Value, Incentives, and Agency Costs	p. 151
Characteristics of Debt and Equity	p. 155
Choice of Capital Structure	p. 157
Making the Capital Structure Decision	p. 169
Conclusions	p. 173
References	p. 174
Notes	p. 174
The Term Structure of Interest Rates	p. 177
Introduction	p. 177
Introduction to the Term Structure of Interest Rates	p. 177
Theories of the Term Structure	p. 182
Term Structure Models	p. 185
Conclusions	p. 203
References	p. 204
Notes	p. 204
Valuing Forward Contracts	p. 207
The Difference between Pricing and Valuation for Forward Contracts	p. 207
Principles of Pricing and Valuation for Forward Contracts on Assets	p. 209
Principles of Pricing and Valuation for Forward Contracts on Interest Rates	p. 219
The Relationship between Forward and Futures Prices	p. 225
References	p. 226
Notes	p. 226
Basic Principles of Option Pricing	p. 229
Factors Affecting Option Prices	p. 229
Put-Call Parity	p. 230
One-Step Binomial Model and The Riskless Portfolio	p. 233
Delta Neutrality and Simple Delta Hedging	p. 235
Risk-Neutral Valuation	p. 241
Real versus Risk-Neutral	p. 242
The Black-Scholes-Merton Pricing Formula	p. 243
The Greeks	p. 248
Implied Volatility	p. 250
Intrinsic versus Time Value	p. 252
References	p. 252
Notes	p. 252
Index	p. 255
Table of Contents provided by Ingram. All Rights Reserved.

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The Professional Risk Managers' Guide to Finance Theory and Application

0071546472

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Summary

Author Biography

Table of Contents

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