London School of Economics and Political Science (LSE)

Modules

Financial intermediation [29]

Note: this is a replacement unit for 100 Banking operations and risk analysis. Please note that the subject guide for this unit may not be available until 1 September 2005.

Prerequisites (if taken as part of a BSc degree):
24 Principles of banking and finance or 94 Principles of banking

The unit addresses both theoretical and practical aspects of financial intermediation and financial risk management. The syllabus brings together the upstream issues of risk measurement and management with the downstream issues of the process of risk management and the implementation of hedging programmes. Whereas traditional risk management focused on a bank's banking book (i.e. on-balance sheet assets and liabilities), modern risk management is concerned with both the banking book and the trading book, which mainly consists of off-balance sheet financial instruments.
Section 1: Theories of financial intermediation: Types and characteristics of financial intermediaries; Financial intermediation as delegated monitoring; Liquidity transformation, bank runs and maturity transformation; Financing sources and borrower characteristics; Introduction to market microstructure.
Section 2: Risks in banking : Investigation of the principal risks in banking, including credit risk, liquidity risk, interest rate risk, market risk, sovereign risk, solvency risk, and operational risk; The risk management process; Risk measurement; Value at Risk techniques.
Section 3: Credit risk : Default risk, exposure risk and recovery risk; Internal and external credit ratings and the uses of rating systems; Principles of credit risk management; Credit risk models.
Section 4: Balance sheet management, liquidity risk and interest rate risk : Asset and liability management; Techniques for managing assets and liabilities; The liquidity gap; Interest rate gaps.
Section 5: Capital requirements and securitisation : Capital adequacy and regulation of financial intermediaries; Economic capital; Securitisation for capital management; The mechanics of securitisation.
Section 6: Analysing bank performance : Accounting and market value based performance measures; Risk-adjusted performance. Risk-adjusted return on capital; Economic value added.
Section 7: Risk Management : Derivatives pricing and hedging: linkages between the state preference model and arbitrage pricing, between option pricing models and delta hedging, and between forward pricing and hedging. Hedge ratios; Managing credit risk with derivatives, including forwards, options, swaps, credit linked notes, and collateralized debt obligations; Managing interest rate risk with swaps; Managing foreign exchange risk with the forward hedge, money market hedge, and currency swaps.