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Financial Instruments & Technology

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The use of complex derivatives instruments to transfer and hedge risks have grown significantly since 1970s, but the use of these instruments often create risks itself. This slidecast discusses the …

The use of complex derivatives instruments to transfer and hedge risks have grown significantly since 1970s, but the use of these instruments often create risks itself. This slidecast discusses the relationship between complex derivative instruments and risk management with a focus on technological tools that are available to C-Suite executives and the CA profession. It closes with hot topic in the field.


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  • 1. Financial Instruments & Technology
    Complex Derivatives Instruments &
    Risk Management
    UNIVERSITY OF WATERLOO
    Acc 626 IT Assurance and CAATs
    Kelly Wong
    July 2011
  • 2. Complex Derivatives Instruments
    “Derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” – Warren Buffet (2002)
    Definition: derivatives with payoff often that are non-linear or path dependent ; mainly OTC
    Examples: Exotic Options, Credit Default Swaps (CDSs),Collateralized Debt Obligations (CDOs)
  • 3. Risk Management
    COSO Framework
    Help C-Suite executive to design control procedures and the formulation of risk management policies, such that unforeseen and undesirable outcomes are minimized.
    Enterprise Risk Management (ERM)
    Value-at-Risk
    Stress Test
  • 4. Tools for Risk Management
    Value-at-Risk (VaR)
    Calculates the maximum loss that a firm can suffer over a defined period of time at a given probability level.
    Historical Scenarios - Excel can handle
    Monte Carlo Simulations - Heavy computing power
    Examples of ASP:
    GoldSim Technology Group
    FactSet Research Systems
  • 5. Tools for Risk Management
    Stress Testing
    “the potential effects on a firm’s financial condition of a set of specified changes in risk factors, corresponding to exceptional but plausible events “ – Bank of International Settlements
    Example of ASP:
    ForexManage’siDeriv
    Key Players:
    Thomson Reuters, Bloomberg, Murex, Algorithmics
  • 6. Why should CA care?
    Many at C-Suite level
    Internal or external auditor
    Market makers
    Regulators
    Academia
    …It’s interesting! 
  • 7. Tools For Auditors
    Risk Assessment - CAATs
    Example:
    Pattern Analysis – Fraud Detection
    System Testing – Due to lack of audit trail
    Valuation Tools
    Data providers: Bloomberg, Thomson Reuters
    ASP: FINCAD ‘s “Auditor Insight”
  • 8. Hot Topic: Regulatory Outsourcing
    Definition: The criticism of regulators delegating and outsourcing the responsibility of regulating a wide range of risk transfers in the economy to computer-based risk models.
    New Rules: Dodd-Frank Act to Basel III and Solvency II
  • 9.
  • 10. Thank you!
  • 11. Works Cited
    Adams, James. “Stress Testing- Drafting a "Battle Plan" for the CRE Portfolio” Sage Works. April 2011. Web. 25 June 2011.<http://www.sageworksinc.com/datareleases.aspx?article=38>.
    Beaver, W. “Financial Ratios as Predictors of Failure.” Journal of Accounting Research. 1966. Page 71-111
    Berry, Romain. “An Overview of Value-at-Risk: Part III – Monte Carlo Simulations VaR.” J.P. Morgan Investment Analytics & Consulting. March 2009. Web. 25 June 2011. <http://www.jpmorgan.com/tss/General/Risk_Management/1159380637650>.
    Berry, Romain. “Stress Testing Value at Risk.” J.P. Morgan Investment Analytics & Consulting. June 2009. Web. 25 June 2011. <http://www.jpmorgan.com/tss/General/Stress_Testing_Value-at-Risk/1159389400084>.
    Bhugaloo, Sam. “Commodities Trading: Nick Leeson, Internal Controls and the Collapse of Barings Bank.” Web. 25 June 2011. <http://www.tradefutures.co.uk/Nick_Leeson_Barings_Bank.pdf>.
    Carney, J. G. Industry models for enterprise data management in financial markets. IBM Journal of Research and Development 54, 2 (March 2010), 193-205. Web. 27 June 2011. <http://dx.doi.org.proxy.lib.uwaterloo.ca/10.1147/JRD.2009.2038750>.
    Cowan, Adrian M. “Derivatives Use in Bank Risk Management: the number of banks using derivatives for risk management purposes is approaching 10 percent.” Bank Accounting & Finance. Volume 19; Issue 5. 2006. Web. 12 June 2011. < http://global.factiva.com.proxy.lib.uwaterloo.ca/aa/?ref=BACF000020060831e28100002&pp=1&fcpil=en&napc=S&sa_from=>.
    Das, Satyajit. Traders Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives. 2006. Financial Times - Prentice Hall. London.
    Davidson, C. "The age of change." Risk  1 Dec. 2010: ABI/INFORM Global, ProQuest. Web.  26 Jun. 2011.< http://proquest.umi.com.proxy.lib.uwaterloo.ca/pqdweb?index=26&did=2210005061&SrchMode=3&sid=1&Fmt=3&VInst=PROD&VType=PQD&RQT=309&VName=PQD&TS=1307753290&clientId=16746&aid=1>.
    Fragniere, E., Tuchschmid, N.S., & Zhang, Q. “Liquidity Adjusted VaR Model: An Extension.” Web. 25 June 2011. <http://campus.hesge.ch/tuchschmidn/pdfs/LiquidityVaR.pdf>.
    Gerding, Erik. “Code, Crash, and Open Source: The Outsourcing of Financial Regulation to Risk Models and the Global Financial Crisis.” Washington Law Review. 2009. Web. 5 June 2011. <http://proquest.umi.com.proxy.lib.uwaterloo.ca/pqdweb?index=1&did=1797647271&SrchMode=2&sid=1&Fmt=4&VInst=PROD&VType=PQD&RQT=309&VName=PQD&TS=1307734762&clientId=16746>.
    Jones., M.T., Majnoni, G. & Peria, S.M. “Stress Testing of Financial Systems: An Overview of Issues, Methodologies, and FSAP Experiences.” IMF Working Paper. June 2001. Web. 25 June 2011. < http://www.imf.org/external/pubs/ft/wp/2001/wp0188.pdf>.
    Keenan, Joy. "Risk and Reward." CAmagazine. 2005. Web. 20 June 2011. <http://www.camagazine.com/archives/print-edition/2005/may/regulars/camagazine19537.aspx>.
    Micallef, Mario. “The New World of Risk-based Regulation.” Information Systems Control Journal. Volume 6. Web.  8 June 2011. < http://www.isaca.org/Journal/Past-Issues/2007/Volume-6/Pages/The-New-World-of-Risk-based-Regulation-Part-1.aspx>.
    Seyedalikhani, Armita. “FINCAD Introduces a New Online Derivatives Valuation Tool for Auditors.” April 2008. Web. 23 June 2011. <http://www.fincad.com/news-events/2008/04282008.aspx>.
    Shore, B., and S. Manwani. "The Financial Crisis on Wall Street: Complexity, Stability, and Information Technology." Journal of Global Information Technology Management 12.1 (2009): 1-5. ABI/INFORM Global, ProQuest. Web. 21 May 2011. < http://proquest.umi.com.proxy.lib.uwaterloo.ca/pqdweb?index=3&did=1648900041&SrchMode=2&sid=2&Fmt=6&VInst=PROD&VType=PQD&RQT=309&VName=PQD&TS=1304976620&clientId=16746>.
  • 12. Works Cited(continued)
    Sorge, Marco. “Stress-testing financial systems: an overview of current methodologies.” BIS Working Paper. December 2004. Web. 23 June 2011. <http://www.bis.org/publ/work165.pdf>.
    Stulz, Rene M. “Should We Fear Derivatives?" June 2004. Web. June 27, 2011. <http://home.cerge-ei.cz/petrz/FM/derivatives_shultz.pdf>. 
    Uryasev, Stan. “Conditional Value-at-Risk (CVaR): Algorithms and Applications.” Web. 25 June 2011. <http://www-iam.mathematik.hu-berlin.de/~romisch/SP01/Uryasev.pdf>.
    “Algorithmics Software.” Web. 23 June 2011. <http://www.algorithmics.com/EN/services/>.
    “Auditing Derivative Instruments, Hedging Activities, and Investments in Securities.” AICPA. 2001. Web. 25 June 2011. <http://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-00332.pdf>.
    “Case Studies: MS Excel VaR Application.” Zircon Computing. Web. 25 June 2011. <http://www.zircomp.com/content/ms-excel-var-application>.
    “Enterprise GRC.” Thomson Reuters. 2011. Web. 25 June 2011. <http://paisley.thomsonreuters.com/website/pcweb.nsf/pages/ARAE-6XLR96>.
    “Enterprise Risk Management Software Solutions.” Metric Stream. 2011. 25 June 2011. <http://www.metricstream.com/solutions/enterprise_risk_management.htm>.
    “GoldSimTechnology Group.” Web. 25 June 2011. <http://www.goldsim.com/Home/>.
    “Integrated risk management and portfolio modeling for the enterprise.” Algorithmics Software. 2007. Web. 23 June 2011. <http://www.algorithmics.com/EN/media/pdfs/Algo-FS0007-AlgoRiskWeb.pdf>.
    "Internal Control Issues in Derivatives Usage." Committee of Sponsoring Organizations (COSO). Web. 12 June 2011. <http://www.coso.org/IC-Issues-Derivatives-Usage_Summary.htm>.
    “Kondor Trade Processing.” Thomson Reuters Risk Management. 2011. Web. 23 June 2011. <http://thomsonreuters.com/content/financial/pdf/enterprise/KondorTradeProcessing.pdf>.
    “Monte Carlo Value at Risk Analysis.” FactSet. Web. 25 June 2011. <http://www.factset.com/websitefiles/PDFs/brochures/mcvar>.
    “Murex S.A.S.” Web. 23 June 2011.<http://www.murex.com/company.php>.
    “Overview of Enterprise Risk Management.” Casualty Actuarial Society. May 2003. Web. 25 June 2011. <http://www.casact.org/research/erm/overview.pdf>.
     “Portfolio and Risk Analytics. Bloomberg Solutions. 2011. Web. 28 June 2011. <http://www.bloomberg.com/solutions/bloomberg_enterprise/portfolio_risk_analytics/>.
    “Portfolio and Risk Management.” Bloomberg Professional. 2011. Web. 28 June 2011. <http://www.bloomberg.com/professional/portfolio_risk_management/>.
    “Risk Management for Interest Rate Derivatives: iDeriv.” ForexManage. 2008. Web. 25 June 2011. <http://www.forexmanage.com/FXM/NewHome/template/default.asp?PageId=10>. 
    “SAS for Enterprise Risk Management.” SAS Institute Inc. Web. 25 June 2011. <http://www.sas.com/solutions/riskmgmt/>.
    “Stress Testing by Large Financial Institutions: Current Practice and Aggregation Issues.” CGFS Publications. April 2000. Web. 25 June 2011. < http://www.bis.org/publ/cgfs14.pdf>.
    “2002 Annual Report: Letter to Shareholders.” Berkshire Hathaway Inc. Web. 12 June 2011. <http://www.berkshirehathaway.com/2002ar/2002ar.pdf>.