Why does it make sense for a company to purchase insurance?

Purchasing insurance decreases the likelihood of having to raise costly external costly. Having to raise costly capital could cause a firm to forgo new investment and profitable projects, or cause new projects to be unprofitable. Insurance prevents the firm form having to use internal funds to pay for losses. It also decreases the likelihood of financial distress which affects the conditions at which claimants contract with the firm. Because the firm would have to pay claimants for risk, it is cheaper to purchase insurance to cover those risks.

What are the assumptions for the CAPM to work?

In order for the CAPM to work, the firm has to be publicly traded and have many shareholders with diversified portfolios. CAPM assumes that management of a firm is risk neutral and there are no agency problems. It also assumes that there are no taxes or transaction costs. CAPM is a model that suggests that risk management does not add value to a firm. The problem with that is the assumptions under CAPM are unrealistic. In a real market, there are taxes and transaction cost and management does not always make risk neutral decisions. For these reasons, risk management can add value to a firm when done efficiently.

Why does risk management create value?

The goal of risk management is to maximize the the value to shareholders by minimizing the cost of risk. It is known that risk is costly. Risk management enables a firm to identify risk and exposure, this allows them to protect themselves against those risks.

Monthly Financial Reports for Banks

An article from CNN (http://money.cnn.com/2009/01/20/news/companies/bank_data.reut/index.htm) writes The Treasury Department is requiring that all banks that received aid through the Trouble Asset Relief Program submit monthly reports on lending activities and data on mortgage-backed securities and asset-backed securities. Some of these banks include Bank of America, Wells Fargo, JP Morgan, and Citigroup. The purpose of the financial aid was to strengthen and restore lending activity for consumers and businesses, but some critics argue that banks are not taking full advantage of this bailout cash by not creating loans. Submitting these monthly reports should drive the banks to create more loans. Why is this important? Financial institutions, such as banks, are a vital component of our economy. They provide loans for consumers for houses, our single most valuable asset, automobiles, and other needs while investing in our businesses. When they fail, the economy fails. We are not going to dig ourselves out of this recession without restoring the strength of one of the basic building blocks of our economy.

Economic Stimulus

An article on CNN(http://money.cnn.com/galleries/2009/news/0901/gallery.stimulus/index.html), talks about how the $825 billion stimulus will affect us. The article states that the purpose of the stimulus is not to turn the recession around, not that it could, but to slow it down. Some effects will be seen immediately while others will not be visible for some years to come (ex. unemployment). Some Republicans are worried this stimulus will create a greater national deficit and that the best approach is in heavier tax cuts and lighter government spending. Democrats argue that the loss from increasing unemployment, economic output, and lost tax revenues will exceed that of the stimulus. It is my belief that the stimulus plan will be somewhat effective. The current state of this recession needs both a long term and short term solution. The stimulus provides a little bit of both. It is not the sole solution, but for a deficit of this magnitude, there is no single resolution. We need long term security, but people also need a means by which to satisfy their immediate needs.

Intro

Blogs for RMI 4750 Class