Risk Management Test 1

Nikolas Kopsiaftis

Problem Set 1

1. JP Morgan suffered a severe loss of about $2 million during a time of very volatile markets. It was due to derivative bets using credit default swaps on a portfolio of corporate debt. JP Morgan was not the only company at fault, there was a chain of betting on sub-prime mortgages that were not well reviewed and analyzed in the first place to assess true risk. The accident occurred because sub-prime mortgages were considered risky but highly profitable which made them look attractive. The problem was that there was a poor assessment on the risk of these mortgages which led to CDOs that were also weak in nature. Ratings agencies failed to recognize the true riskiness of these securities and gave them high ratings when in fact they did not deserve such ratings. JP Morgan took on these CDOs without putting their own research into the securities and eventually there were many defaults and a lot of losses. Based on this example it is easy to see that risk management is very important to the investment world. Had there been an accurate assessment of risk in the first place then perhaps such losses would have never occurred. The models were not flawed, they were just inadequate and this shows that further risk investigation may have saved JP Morgan a lot of money.

4. Which stock has the highest and lowest average return?

Based on a book price in accordance with the stock price given on 11/8/2012, AAPL had the highest average return and ACN had the lowest average return.

Does the stock with the highest return carry the biggest risk (standard deviation of returns)?

According to the standard deviation of returns, yes.

Does the stock with the lowest return carry the smallest risk (standard deviation of returns)?

According to the standard deviation of returns, no.