Management of Financial Risk
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Transcript Management of Financial Risk
Tools for risk management
Zvi Wiener
02-588-3049
http://pluto.mscc.huji.ac.il/~mswiener/zvi.html
Jun-00
Risk Management
Tools
Measurement tools
Financial tools
– options
– forwards, futures
– swaps
– insurance
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Outsourcing
Jun-2000
slide 2
Senior Management
Marketing
Finance
Supply
Cashflow
Capital
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Jun-2000
slide 3
Important Principles
Distinction between risk taking and risk control.
Backtesting.
Transparent reporting.
Timing is more important then precision!
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slide 4
Basic decisions
Goal of Risk Management
Base currency
Time horizon (embedded options)
Economic or Accounting approach
Admissible
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risk
Stop losses or other actions
Jun-2000
slide 5
Risk Management System Can NOT
Predict future
Identify business opportunities
Be always right!
Risk Management System Can
Predict loss, given event
Identify most dangerous scenarios
Recommend how to change risk profile
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Jun-2000
slide 6
Measurement Tools
CATS, CARMA
Algorithmics, Risk Watch
Infinity
J.P. Morgan, FourFifteen
FEA, Outlook
Risk Manager, RMG
Theoretics, TARGA
Bankers Trust, RAROC
INSSINC, Orchestra
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Jun-2000
$400K/yr
>$1M
>$1M
$25K/yr
$18K
$30K/yr
$75K
$50K/run
$25-75K
slide 7
Definition
VaR is defined as the predicted worst-case
loss at a specific confidence level (e.g. 99%)
over a certain period of time.
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Jun-2000
slide 8
VaR
1
0.8
0.6
0.4
VaR1%
1%
0.2
Profit/Loss
-3
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-2
-1
1
Jun-2000
2
3
slide 9
Benchmarking
Financial assets
– create an imaginary portfolio and measure
performance relative to this portfolio.
Industry
– measure relative to competitors.
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Jun-2000
slide 10
Financial Tools
Risk Management Tools
Options
Futures/Forwards
SWAP
FRA
Insurance
Jun-2000
slide 11
Derivatives
Contracts that are priced according to underlying
variables (prices are derived from underlying).
Options, Futures, Forwards, Swaps, Warrants, etc.
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Jun-2000
slide 12
Derivatives
Contingent claims
gold shipped
KTUBA
insurance
an option not to undertake a project
an option to leave
an option to change price
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Jun-2000
slide 13
Financial Tools
Risk Management Tools
Options
Futures/Forwards
SWAP
FRA
Insurance
Jun-2000
slide 14
Forward and Futures
Forward agreement
Futures - standard traded contracts
– margin
– mark to market
Final result is very similar
– settlement risk
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Jun-2000
slide 15
Forward payoff
Forward at maturity
Underlying asset
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Jun-2000
slide 16
Forward Price
Note that forward price is not a price
Forward price does NOT depend on the
expected exchange rate. It depends on the
current exchange rate and interest rates only!
It is important to chose appropriate time
horizon!
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Jun-2000
slide 17
Forward Price
Consider a NIS/USD forward contract for
10,000 USD to be exchanged in 6 months to
NIS according to the forward price.
Current exchange rate is $1=4NIS,
– USD interest rate is 6%
– NIS interest rate is 10%
How to define the forward rate?
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Jun-2000
slide 18
Forward Price
Buy 6 month T-bill, $10,000 nominal, it
will cost 10,000*4/1.03= 38,835 NIS
Sell 6 month MAKAM, for 38,835 NIS
This will guarantee that in 6 months you will
receive $10,000 and pay 38,835*1.05 NIS.
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slide 19
Forward Price
(1 rNIS )
F S
T
(1 rUSD )
T
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Jun-2000
slide 20
Hedge using Forward
Current exchange rate 4.00
USD interest rate
6%
NIS interest rate
10%
In a year you will receive $100 and will have
to pay 410 NIS.
Enter into a forward for 1 year for $100.
Forward price is 4.00*1.1/1.06=4.15.
The time match is important!
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Jun-2000
slide 21
After a year
$
3.9
4.0
4.1
4.2
4.3
Forward
25
15
5
-5
-15
Your balance
3.9*100-410+25= 5
4.0*100-410+15= 5
4.1*100-410+ 5 = 5
4.2*100-410- 5 = 5
4.3*100-410-15 = 5
Complete protection with no cost!
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Jun-2000
slide 22
What if there is no perfect time
match?
One can use shorter contracts and roll them
over. This will neutralize completely the
exchange rate risk, but you will have some
interest rate risk.
Do it very carefully!
Or better use OTC, but check prices.
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Jun-2000
slide 23
Marking to Market
Your balance
Initial
margin
Maint.
margin
margin call
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Jun-2000
time
slide 24