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by: Naya Rhodes

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# Principles of Insurance, Week 4, Chapter 5 36081

Marketplace > Kent State University > Finance > 36081 > Principles of Insurance Week 4 Chapter 5
Naya Rhodes
KSU
GPA 3.4

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These will be the last notes that will be on the exam. Study guide coming soon!
COURSE
Principles of Insurance
PROF.
David Dumpe
TYPE
Class Notes
PAGES
1
WORDS
CONCEPTS
Insurance, Risk, riskmanagement, Risk Management, Risk Management and Insurance, Risk and Return
KARMA
25 ?

## Popular in Finance

This 1 page Class Notes was uploaded by Naya Rhodes on Sunday September 25, 2016. The Class Notes belongs to 36081 at Kent State University taught by David Dumpe in Fall 2016. Since its upload, it has received 3 views. For similar materials see Principles of Insurance in Finance at Kent State University.

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Date Created: 09/25/16
PrinciplesofInsurance Chapter5:DiversificationandHedging -Riskbearingfinancialinstitutionsareorganizationsthatcollectivelyassumetherisksoflargegroupsof consumersbyusingriskdiversificationtoreduceriskwithingroups.Someexamples:pensions,mutualfunds,and insurancecompanies -Thestateofeconomytableshowsreturnsindifferentsituations.Theinterrelationshipofreturnsandstocksis measuredbythecovariance.Thiscanbecalculatedinathreestepprocess: 1.Calculatetheexpectedvalueofthereturnsofthestocksinquestion. 2.Subtracttheexpectedvalueofreturnfromthereturn.Dothisforbothstocks. 3.Multiplythedifferencesinreturnsofthefirstandsecondstockbytheprobabilityofoccurrence.The sumofthetwoproductswillgiveyouthecovariance. -Creatingaportfolio:interrelationshipsbetweeninvestmentsacrossdifferentstatesoftheeconomy. -Correlationcoefficientrangesfrom-1to1andhaspositive/negativeanduncorrelatedimplications.Perfect positivecorrelationamongriskexposuresisunlikely.Thisiswhencorrelationis1. -Naturaldiversificationoccursacrossuncorrelatedrisks.Bundlingnegativelycorrelatedriskexposures dramaticallyreducerisk(hedging).Hedgingiswhenyoutaketwofinancialpositionssimultaneouslysotheirgains canoffseteachother.Someexamples: 1.Currencyriskiswhenunfavorablefluctuationsinthevalueofdomesticcurrencyrelativetoforeign currencyresultinlosspotential. 2.Interestrateriskisthelosspotentialthatoccurswhenchangesininterestratesreducethemarketvalue offixed-incomesecurities. 3.Commoditypriceriskisthefluctuationsinpricesforawiderangeofcommodityproducts. -Derivativesarefinancialinstrumentswhosevalueisbasedonthatofanunderlyingfinancialasset.Some examples: 1.Futurescontractistheordertobuyorsellanassetlaterataspecifiedprice. 2.Forwardcontractisthesameasafuturescontractbutnottradedonanorganizedexchange. 3.Swapsarewhencounterpartiesexchangecashflowsofoneparty’sfinancialinstrumentforthoseof theotherparty’sfinancialinstrument. 4.Calloptionistherightbutnottheobligationtobuytheunderlyingasset. 5.Putoptionistherightbutnottheobligationtoselltheunderlyingasset. -Riskmanagementattheboardroomlevelincreasesconsistencyandnegotiationpower.ERMisaholistic approachtoriskmanagement.

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