Appendix E: Portfolio Risk Reduction Diversification ... ?· Diversification andDiversification and…

  • View
    213

  • Download
    0

Embed Size (px)

Transcript

  • 2/14/2008

    1

    Appendix E:Portfolio

    Diversification andDiversification and and Risk

    Risk Reduction

    Risk Reduction Strategies for Media Projects

    1. Insurance2. Shift risk to

    investors/buyers/suppliersi ifi i3. Diversification

    4. Breaking up projects into stages, with several go/no go decisions for financing

    5. Hedging

    How can media firms reduce the riskiness

    Media Finance and Risk

    of investment?

  • 2/14/2008

    2

    Diversify investment portfolio (ie: conglomerate mergers).

    Choose appropriate debt pp pmaturity structure to reduce liquidity risk.

    Evaluate if the new project fits the firms corporate and business level strategy.

    How to evaluate if an investment fits the firm

    strategy?

    -- and therefore minimize investment risk

    How can media firms reduce the riskiness

    of investment?

  • 2/14/2008

    3

    Risk Management

    Problem of Risk Estimation

    An average calculated from a given sample of movies will be a poor forecast of the average ina poor forecast of the average in the future. Because the average is unstable, it is a poor estimator of the expected next event.

    De Vany and Walls, Does Hollywood Make Too Many R-Rated Movies? Risk, Stochastic Dominance, and the Illusion of Expectation Journal of Business, July 2002, vol. 73, no. 3

    The stable Paretian model is the right model.

    De Vany and Walls, Does Hollywood Make Too Many R-Rated Movies? Risk, Stochastic Dominance, and the Illusion of Expectation Journal of Business, July 2002, vol. 73, no. 3

    Fig. 3. Normal and stable Paretian distributions of revenueN

    De Vany and Walls, Does Hollywood Make Too Many R-Rated Movies? Risk, Stochastic Dominance, and the Illusion of Expectation Journal of Business, July 2002, vol. 73, no. 3

  • 2/14/2008

    4

    The probability distribution is highly skewed and is not symmetrical. Most of the probability mass is placed on the

    f lmost frequent, low-revenue outcomes.

    De Vany and Walls, Does Hollywood Make Too Many R-Rated Movies? Risk, Stochastic Dominance, and the Illusion of Expectation Journal of Business, July 2002, vol. 73, no. 3

    The mean revenue is much higher than the most probable revenue.

    De Vany and Walls, Does Hollywood Make Too Many R-Rated Movies? Risk, Stochastic Dominance, and the Illusion of Expectation Journal of Business, July 2002, vol. 73, no. 3

    This is different from a normal distribution where the most probable outcome (the peak of the probability density curve) equals the mean.

    De Vany and Walls, Does Hollywood Make Too Many R-Rated Movies? Risk, Stochastic Dominance, and the Illusion of Expectation Journal of Business, July 2002, vol. 73, no. 3

    The tails of the distributions are where the important events are located.

    De Vany and Walls, Does Hollywood Make Too Many R-Rated Movies? Risk, Stochastic Dominance, and the Illusion of Expectation Journal of Business, July 2002, vol. 73, no. 3

  • 2/14/2008

    5

    Risk of potential embarrassment if a rejected project becomes

    th t di hitanother studios hit.

    Epstein, Edward Jay, The Big Picture, The New Logic of Money and Power in Hollywood, New York: E.J.E. Publications, Ltd., Inc., 2005

    For example, Universal Pictures, after spending more than three years developing the script ofyears developing the script of Shakespeare in Love, finally decided not to green-light it and instead put it in turnaround.

    Epstein, Edward Jay, The Big Picture, The New Logic of Money and Power in Hollywood, New York: E.J.E. Publications, Ltd., Inc., 2005

    Disneys subsidiary Miramax bought it and produced it, and the fil t t ifilm went on to win seven Academy Awards, including Best Picture of 1998.

    Epstein, Edward Jay, The Big Picture, The New Logic of Money and Power in Hollywood, New York: E.J.E. Publications, Ltd., Inc., 2005

    In turning down projects, there is also the risk of alienating

    d di t d t llproducers, directors, and stars, all of whom a studio may need for future films.

    Epstein, Edward Jay, The Big Picture, The New Logic of Money and Power in Hollywood, New York: E.J.E. Publications, Ltd., Inc., 2005

  • 2/14/2008

    6

    As one Hollywood agent explained, Whatever the fi i l l l it t k t lfinancial calculus, it takes a truly brave studio head to reject the movies of stars they value.

    Epstein, Edward Jay, The Big Picture, The New Logic of Money and Power in Hollywood, New York: E.J.E. Publications, Ltd., Inc., 2005

    Potential Risk Treatments Risk Transfer Risk Avoidance Risk Reduction Risk Retention

    Source: Wikipedia website Risk Management http://en.wikipedia.org/wiki/Risk_management

    Risk Transfer

    Causing another party to accept the risk, typically by...

    Contract [ie: insurance] Hedging [ie: derivatives]

    Source: Wikipedia website Risk Management http://en.wikipedia.org/wiki/Risk_management

    Risk Avoidance Not performing an activity that

    could carry risk. Might forgo the potential gain.

    ie: not buying a property or business to avoid the liabilitySource: Wikipedia website Risk Management http://en.wikipedia.org/wiki/Risk_management

  • 2/14/2008

    7

    Risk Reduction Involves methods that reduce

    the severity of the loss.ie: Modern software

    development methodologies reduce risk by developing and delivering software incrementally

    Source: Wikipedia website Risk Management http://en.wikipedia.org/wiki/Risk_management

    Risk Retention Involves accepting the loss when

    it occurs.ie: any amounts of potential loss

    (risk) over the amount insured

    Source: Wikipedia website Risk Management http://en.wikipedia.org/wiki/Risk_management

    Risk Retention is acceptable if the chance of a very large loss is small or if the cost to insure for greater coverage amounts isfor greater coverage amounts is so great it would hinder the goals of the organization too much. Source: Wikipedia website Risk Management http://en.wikipedia.org/wiki/Risk_management

    Areas of risk management(Basel II framework)

    Market Risk (price risk)Market Risk (price risk) Credit Risk Operational Risk

    Sources: Bank for International Settlements -http://www.bis.org/publ/bcbs118.htm

  • 2/14/2008

    8

    Basel II three pillars concept-- to promote greater stability

    in the financial system

    Minimum capital requirementsMinimum capital requirements Supervisory review Market discipline

    Sources: Bank for International Settlements -http://www.bis.org/publ/bcbs118.htm

    Hedging and Corporate Ri k M tRisk Management

    What sorts of risks should be hedged?

    Should they be hedged partially of fully?of fully?

    What kind of instruments will best accomplish the hedging objectives?

    Building optimal hedging strategy...

    When external finance is more tl th i t ll t dcostly than internally generated

    funds, it makes more sense for firms to hedge.Kenneth A. Froot, David S. Scharftein, Jeremy C. Stein, Risk Management: Coordinating Corporate Investment and Financing Policies in The Journal of Finance. Vol XLVIII, NO.5 December 1993

  • 2/14/2008

    9

    Optimal hedging strategy does not insulate firm value from marketable sources of risk.

    Optimal hedging strategy will d d b th th t fdepend on both the nature of the product market competition and the strategy adopted by competitors.

    Kenneth A. Froot, David S. Scharftein, Jeremy C. Stein, Risk Management: Coordinating Corporate Investment and Financing Policies in The Journal of Finance. Vol XLVIII, NO.5 December 1993

    Firms will want to hedge less, the more closely correlated are their cash flows with future investment opportunities.

    Firms will want to hedge more, the gmore closely correlated are their cash flows with collateral values (and hence their ability to raise external finance.)

    Kenneth A. Froot, David S. Scharftein, Jeremy C. Stein, Risk Management: Coordinating Corporate Investment and Financing Policies in The Journal of Finance. Vol XLVIII, NO.5 December 1993

    Multinational firms will have to take in more considerations when hedging, such as exchange rate.

    Nonlinear hedging instruments (ie: options) allows firms to(ie: options) allows firms to coordinate risk management more precisely than linear ones (ie: futures and forwards).

    Kenneth A. Froot, David S. Scharftein, Jeremy C. Stein, Risk Management: Coordinating Corporate Investment and Financing Policies in The Journal of Finance. Vol XLVIII, NO.5 December 1993

    Fund(2001)

    Fund Manager

    Net Assets In Top 10Holdings

    1-Year Total

    Return

    Expense Ratio

    Least Risky

    AIM Global Utilities Fund (AUTLX) Team Managed 22.93% 30.43% 1.06%Gabelli Global Telecom Fund (GABTX)

    Mario J. Gabelli and Marc Gabelli 25.67 29.05 1.6

    Riskier

    Fidelity Select Telecom (FSTCX) Peter Saperstone 49.35 27.04 1.09T. Rowe Price Media& TelecommunicationsFund (PRMTX)

    Robert N. Gensler 27.75 43.86 1.03

    Montgomery Global Communication Fund (MNGCX)

    Oscar Castro and Stephen Parlett 23.61 46.35 1.68

    Riskiest

    Invesco Telecomm.Fund (ISWCX) Brian B. Hayward 26.77 85.6 1.24Fidelity Select Developing Communications (FSDCX) Rajiv Kaul 47.95 90.95 1.11

    Source: Morningstar (Aug 16, 2001)

  • 2/14/2008

    10

    A studio or other media company pools numerous risky projects, making their aggregate cash flow

    Risk Reduction Strategy #3:Diversification

    making their aggregate cash flow reasonably safe for the lender.

    A venture capital fund pools numerous projects for investm