Jan 22, 2011

Seminar: Financial Risk Management: A Brief Overview

Date: 14th January, 2011

Speaker: Dr. Puneet Prakash

About the speaker:

Dr. Puneet Prakash is an Assistant professor at Virginia Commonwealth University since 2005. He holds a Ph.D in Risk Management and Insurance from Georgia State University, an MBA from IIFT, Delhi, PG Diploma in Development Policy (IGIDR), and M.Sc. (5-year Integrated) from IIT, Kanpur. He is also a visiting faculty to IIT Kanpur, Fall 2009.

Abstract of the talk:
The seminar started with a brief discussion on market and the categorization of market participants into risk averse, risk neutral and risk seeking behaviors. Dr. Prakash then proceeded to discuss the Modigliani – Miller theorem that Corporations are risk neutral and that if investors want to manage risk they could do it as an individual rather than through the company. The underlying assumption is that a company and a individual have the same capability to manage risk. As this assumption is not a universal truth, not all corporations are risk neutral. Any discussion on risk management invariably involves Jensen’s inequality and this seminar was no exception to this. Dr. Prakash explained in brief Jensen’s inequality for the benefit of the audience which had some undergraduates apart from the usual MBA students.

The concepts of hedging the risk, risk premium and insurance were then dealt with. Dr. Prakash then proceeded to answer when corporations manage risk and their value functions. He also touched upon locating the expected bankruptcy point and expected bankruptcy costs. To ensure that the mixed audience carried his point home he interspersed theory with real life experiences, examples and analogies. Dr. Prakash then explained what is known as integrated risk management. He then mentioned the categorization of risk into operational (business) and financial. The fundamental generic risk management matrix was next on his agenda. This was followed by a small brief on how to practice ERM (Enterprise Risk Management) and what are the origins of financial risk.

The process of financial risk management was then taken up. Dr. Prakash then described various properties of risk viz. coherence, monotonicity positive homogeneity and sub-additivity. He then went on to elaborate on how to compute value at risk given the distribution of return. What followed this macro level discussion was a micro level mathematical model for financial risk management. Financial risk was broken down into market risk, default/credit risk, interest rate risk and liquidity risk. He then discussed generalized extreme value distribution (Fetcher Distribution) which is also known as limit theorem for extreme values) an then he explained how short selling could take a firm from inefficient to efficient part of risk return curve. The informative two hour talk concluded with capital asset pricing model.

Prepared By:
Atul Mishra(matul@iitk.ac.in)

Published By:
PR & Media Cell, MBA-IIT Kanpur (prmba@iitk.ac.in)

Jan 14, 2011

Seminar: Dynamic Credit Rating Standards- Why do they vary over time?

Date : 7th January, 2011

Speaker: Dr. Puneet Prakash

Biography of the speaker:

Dr. Puneet Prakash is an Assistant professor, 2005 – current, at Virginia Commonwealth University. He has done his Ph.D in Risk Management and Insurance from Georgia State University. He completed MBA from IIFT, Delhi, PG Diploma in Development Policy (IGIDR), and M.Sc. (5-year Integrated) from IIT, Kanpur. He is also a visiting faculty to IIT Kanpur, Fall 2009.

Abstract of the talk:
In the paper mentioned, it is examined as to why credit rating standards change over time. Drawing upon the literature on certification intermediaries, it is argued that rating standards are related to the economy-wide credit quality distribution, and as the distribution changes, so do the standards. Empirical tests verify this predicted relationship. In particular, with a rise in economy–wide dispersion of the distribution of credit quality, rating standards become more stringent. However, an increase in mean probability of economy wide default risk has the opposite effect. These findings are robust to not only alternative specifications of measures of location and dispersion of the economy-wide credit quality distribution, but also to the stickiness in ratings.

Dr. Puneet started the discussion by explaining the motivation of the CRAs (Credit Rating Agencies). He explained that the topic has a keen association with the long-term debts. When a firm seeks for some investors, investing companies want to know the credit-worthiness of these issue companies. He then explained the role of CRAs in the society in this context. He explained that a Credit Rating Agency acts as:
a) An information intermediary to come in and analyze Balance Sheet of the issuer. It removes information asymmetry between the issuer (firm seeking for debt) and the investors
b) A monitoring unit: It charges a fee for the service it offers in this respect
c) A Certificate intermediary: It provides an assurance of quality for the issuer.

He next moved on to mention that a credit rating agency takes into account, how much money of its own the issuer is putting into a debt. CRAs have a role of increasing social welfare, collecting information and disseminating it.

The next major topic that he discussed was CRAs and the current crisis they are facing. He explained that in the current scenario, many companies are frequently changing their standards to maintain their market shares. He indicated that these companies have started ignoring interest rate changes in the economy. And as a result, CRAs also ignored interest rate risks. As of now, though, CRAs are regulated much strictly.

Next he came to the main Research Question. He explained a few concepts with the help of three research papers, as enlisted below:
• Blume M., F. Lim and A C MacKinlay (BLM), 1998, “The declining credit quality of U.S. Corporate Debt: myth or reality?”, Journal of Finance, 4, 1389-1413
o Rating Standards become stricter over 1975-1995
• Zhou, 2001, “Credit Rating and Corporate Defaults”, The Journal of Fixed Income , Vol. 11, No. 3: pp. 30-40
o Rating Standards become lag over 1981-1998
• Gordy and Heitfield, “Estimating Default Correlations from Short Panels of Credit Rating Performance Data”, 2002
o Rating standards are time-varying, to explain rating through the cycle

Dr. Puneet followed Gordy and Heitfield (as highlighted above), as the base paper to next explain as to why do CRAs vary their standards over time? He explained that standards are dynamic because they are tied to the underlying economy wide credit risk distribution. So, one should not expect any trend over time. He mentioned that when the average quality of companies as a whole declines, standards are lowered (market share argument). In this case, the CRAs believe that if they do not lower their standards, they will lose their market share. This is due to the fact that the client may get a good rating for more defaults from another CRA in this case. He also argued that as the dispersion of the distribution of credit quality rises, standards are tightened (reputation argument). As its implication, it becomes evident that rating standards have no trends. Instead, these are tied to the underlying risk distribution.

Dr. Prakash then went into the theoretical underpinnings of the model used and developed in the research paper. He stated that a Rating agency is a profit maximizing firm. It is also assumed that a market is characterized by information asymmetry. Ultimately, the problem reduces to a Seller’s problem:
Max (θ – c (θ, t) – P); where θ: debt
C: Cost of obtaining θ
t: Efficiency parameter
P: Price a seller pays to the CRA

On the basis of these theoretical Implications, certain Empirical predictions can be stated as:
• t is time varying:
• P is:
o Directly proportional to the mean value of the underlying quality E(t)
o Inversely proportional to the dispersion

Hence, the dispersion of the distribution of credit quality is taken as a scaling parameter.

He further introduced the issues of measurement where certain mathematical models were explained, based on the Merton model. A ‘Rating Agency model’ was introduced as an econometric model. It was mentioned that the rating thresholds represent the standard different CRAs have. For example, a rating of AAA may mean 10 default points for one CRA while 8 for the other.

The last part of the seminar was the Q/A round, where Dr. Puneet addressed to the students’ and faculties’ queries. The seminar closed with a vote of thanks by Dr. Subhash C. Misra, Faculty, IIT Kanpur. The session proved to be very informative for the students, as they become aware of the major forces affecting the functioning of the rating agencies in a free economy.

Prepared By:
Rubal Mehta(rubalm@iitk.ac.in)

Published By:
PR & Media Cell, MBA-IIT Kanpur (prmba@iitk.ac.in)

Jan 4, 2011

Seminar: Integrating Global Marketing and R&D Management at Novartis

On 29th Dec. 2010, Dr. Subhanu Saxena, the Global Head of Marketing and Sales, General Medicine of Novartis visited the department and provided insights into pharmaceutical industry. During his long career at Novartis, he has handled many challenging roles, dealt with diverse business conditions and travelled to various parts of the globe. His commitment to the field of healthcare is supplemented by his passion towards ancient Indian literature and philosophy.

The seminar was aimed at sharing the speaker's insights in the healthcare industry and share with the audience the various challenges, innovations, technological initiatives and management practices prevalent at Novartis.

Dr. Saxena began by sharing with the audience some information on the healthcare industry in general, and Novartis in particular. The high financial margins of Novartis are indicative of the robustness of business along with diversification of interests to strengthen revenue flows of the company. The amount invested in R&D is very substantial and points out the high priority given to innovation and new drug development over generics. To foster this spirit and ensure high success rates in research, the focus has been on the value proposition of a drug to justify its business case as well as the health economic cost modelling to justify further investments.

Dr. Saxena then proceeded to breif the audience the internal workings of Novartis in the drug testing and clinical trials stage of drug development, called Integrated Product Strategies (IPS). The various stages of drug testing were thoroughly explained emphasising the various checks and procedures prior to human trials. This point was in response to a students query regarding the clinical trials and their thoroughness in detecting side effects during human trials.

Dr. Saxena also shared with the audience the inherent costs associated with new drug development. Since statistically, the discovery of a drug without side effects and having potency is very small, hence the drug discovered needs to be having sufficient revenue generating capability to offset the losses incurred during R&D. This is done by Novartis through the Pathway based R&D approach. By this method, diseases are researched to determine the common pathway of the disease as well as the drug used to treat it. By this, a drug discovered for a rare strain of disease can be used to treat a more widespread ailment, thus expanding the target segment and improving the business case for drug development.

The structure of the company was also explained in depth to show the working of a geographically spread, technology focussed and globally integrated organization. The structure illustrated numerous key aspects of the organization such as preference for in-bred talent pools, diversity in higher management, re-shuffling of verticals to increase exposure and integration of functions for improved synergies.

The audience also were engaged in interactive discussions with the speaker as they looked to gain first hand information about the healthcare sector from his extensive experience. In response to a faculty's query, Dr. Saxena elaborated on how interpreting and acting on consumer behaviour analysis was a vital cog of the product marketing and sales functions to increase their acceptance and boost market shares. In response to a student's query on the cannabalization of sales by generic drug companies limiting the revenue stream from developed drugs, Dr. Saxena shared with him that Novartis has a generic company which is 2nd largest in the world. In this way, the revenue lost is still benefitting Novartis's generic arm.

In conclusion, all the present faculty and students from various students were treated to a highly interactive and informative session by an industry stalwart. The interaction helped all the students understand operations of large firms in competitive environments and got a glimpse into the thought processes of higher management dealing with diverse challenging scenarios while balancing social responsibilities.