Quantative Finance You need to Know

wealth Management and Asset Management are closely related to one another. However, there are differences between the two.

• Wealth management is broader in perspective and includes asset management services, investment management, real estate management, tax planning etc.
• Asset management is related to the management of assets and investments such as stocks, bonds, real estate and also other assest.
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• Risk avoidance is not taking on the risk in the first place by not investing in the product that has the said risks.Risk transfer is akin to buying insurance. You make the investment, are exposed to the risk, but are protected if it happens.

The board of directors sets the firm's risk appetite which is what risks investments they are willing to be exposed to (in the hopes of making money) and what risks they are not.

For the risks the firm is willing to be exposed to in the hopes of making a profit, take they must decide how to handle them.

• They can protect themselves by hedging (investing in products that pay if the risk is realized; like insurance). This is risk transfer.
• They can diversify and bring down the risks that way. This is risk reduction.
• They can ignore them, do nothing and hope for the best. This is retaining the risk

For the risks the firm chose not to be exposed to, they have avoided them (risk avoidance) by not being exposed to them in the first place.

For example: Imagine an airline like Air Canada, in the course of doing their business of flying people around the globe, they are exposed to the risk of increasing prices of jet fuel. Jet fuel costs go up and it eats into their profit. They want to protect against increases in the price of jet fuel in the spot market and the board will say we are OK with our traders taking positions in jet fuel futures (there are no jet fuel futures, but lets pretend there are for simplicity) to protect against adverse price movements. They may not be OK with their traders taking positions in very complicated products like synthetic CDOs.

In this case, they have decided to transfer the risk of the increasing spot price of jet fuel by hedging (investing in futures). They have not avoided it, because if it happens, the price at which they buy jet fuel is going to go up and they will have to pay the higher price. Since they transferred the risk by hedging, it won't negatively affect them since if the price does go up, they will make money from the futures; like an insurance policy.

The board decided not to invest in the super complicated synthetic CDOs and thus have avoided the risk that comes from that investment.

A simpler example would be a company deciding to invest in corporate bonds to make a profit. They are exposed to the risk that the companies they invest in will go bankrupt and their investment loses all its value. To transfer this risk and protect themselves, they can hedge and buy a product that will pay them if one of the companies they invested in defaults.

Risk Manager must-know list

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What are the products, concepts, and models 
a risk manager must know? I'm not looking for an exhaustive list,
but rather a general list as the one in Paul & Dominic's Guide To Quant Careers:

Products: Fixed income, bonds, swaps; Equity, dividends, derivatives; Currencies, role of foreign and domestic interest rates; Commodities, convinience yield et.; Exotics, main types; Credit derivatives.

Concepts: Risk, return and efficient frontiers; Delta hedging; Risk neutrality; The no-arbitrage argument; Market price of risk for non-traded quantities; Calibration; Static hedging using exchange-traded vanillas.

Models: Binomial model; Lognormal; Jump diffusion; Stochastic volatility; Interest rate model (single, multi-factor, HJM, BGM); Credit models (hazard rate, structural); Transition matrices; Numerical methods; Monte Carlo simulation techniques; Binomial scheme; Finite-difference methods; Numerical quadrature; Which method to use for which type of contract.

A list that "will ensure that you don't make an idiot of yourself 
by having major gaps in your knowledge".

What is the difference between asset-backed securities(ABS), covered bonds and collateralized debt obligations (CDO)?

MBS are securities which represent ownership in a pool of mortgages

ABS are securities which represent ownership in a pool 
of assets other than mortgages (for example auto loans
 or credit card loans)

Collateralized Debt Obligation are complex entities which issue tranches of securities to investors and use the proceeds
 to buy MBS, ABS or other assets. The highest tranches
 have priority in receiving cash flows from the owned
 securities, and thus are less risky and less leveraged 
than the lower tranches.

Covered bonds is the English name for Pfandbriefe,
 a German invention. They are debt instruments issued 
by a bank, and are part of the capital structure of that 
bank (unlike the above which are independent securities). 
The pfandbriefe are backed by a pool of mortgages, which serve as a kind of second level guarantee (or "cover") if the bank is unable to repay. In addition the bank is required to put up new mortgages if the old ones expire or default.

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