Functions and Business Models of Financial Institutions

• Commercial banks and deposit takers

1. Maturity transformation model

• Sensitivity of banking sector to market stress

1. Deposit insurance
2. Resolution
3. Living wills
4. Bail in instruments

• Insurance companies

1. Asset/liability management
2. Risk tolerance
3. Economic capital

• Structure and functions of Investment Banks (IB’s)

1. Financing
2. Client facilitation
3. Mergers and Acquisitions

• Contrast business models of buy side firms

1. Asset managers and sell side firms
2. IB’s

• Fund management

1. Pension funds
2. Defined benefit versus defined contribution

• Investment management

1. Performance ratios
2. Benchmarks
3. Passive versus active

• Hedge funds

1. Hedge fund size
2. Assets Under Management (AUM)/incentive fees business model
3. Regulatory oversight

Macro-Economic Drivers of Financial Markets

• Growth Domestic Product (GDP) growth, productivity, employment, capacity utilization
• Increasing role of emerging market (EM) economies, frontier markets and frontier currencies
• Interest rate differentials

1. Comparison of short term rates
2. US, EU, UK, Japanese rates

• Foreign Exchange (FX) carry trade 

1. Traditional pairs and increasing use of dollar as funding currency

• Balance of payments, trade imbalances, capital flows
• Inflation outlooks for developed and developing economies

1. Consumer Price Index (CPI) and Producer Price Index (PPI)

• Productivity differentials

1. Costs for labor and capital, and Return on Investment (ROI)

• Geo-political events

1. Political crises, currency wars, trade policy

Monetary Policy of Central Banks

• Monetary policies of US, EU, UK, Japan and China

1. Quantitative Easing (QE)
2. Outright Monetary Transactions (OMT)
3. Capital controls

• Traditional tools of open market operations

1. Liquidity provisioning, reserves

• Unorthodox techniques

1. QE/asset purchase programs

• Yield curve characteristics

1. Influence of short term rates on long rates

• Macro-prudential tools

1. Scope and purpose

• Status of non-discretionary policy guidelines

1. Taylor ratio

• FX reserves management

1. Role of EM central banks in managing FX rates

• Implications of interest rate policy normalization for asset markets, impact on EM

Overview of Risk Management

• Statistical nature of risk versus absence of probabilistic dimension to uncertainty
• Summarizing the principal types of financial risk
• Types of risk

1. Market risk and capital adequacy
2. Credit risk
3. Liquidity risk
4. Sovereign risk
5. Systemic risk
6. Operational, legal and reputational risk

• Methodological principles of Value at Risk (VaR)

1. Are financial returns normally distributed?

• Risk/reward concepts from Capital Asset Pricing Model (CAPM)
• Modelling risk scenarios

1. Stress testing
2. Regressions based on outlier values
3. Monte Carlo simulations
4. Back testing

• Hedging strategies

1. Use of swaps and other derivatives to manage risk

• Corporate governance issues

1. Conflicts of interest
2. Internal risk control processes
3. Non-executive directors (NED’s)

• Major regulatory initiatives

1. Sarbanes-Oxley
2. Dodd-Frank Act
3. BCBS and Basel II and III
4. Revamped UK regulatory structure
5. Financial Stability Board

Root Causes of Financial Instability and Systemic Risk

• Historical illustrations of investment manias (e.g. South Sea Bubble, 1929 Crash, 1987 Crash, Asian Crisis, Japanese asset markets crash 1990, Nasdaq Collapse 2000/1)
• Special characteristics of the systemic crisis of 2007/8

1. Counter party credit risk
2. American International Group (AIG)

• Financial contagion
• Joint probability of defaults, left tail dependencies, heightened asset movement correlations, tail risk
• Macro-economic theory

1. How satisfactory are mainstream explanations for crashes?

• Credit cycles

1. Boom/bust
2. Excessive leverage
3. Inadequate capital and liquidity

• Minsky’s view of the inherent instability of financial systems
• New directions in explaining “non-rationality” in economic behavior, over-confidence, cognitive and emotional dissonance, “herding behavior”
• Episodic crashes from market micro-structure

1. 1987 program trading
2. 2010 “Flash Crash”