The need risk

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The need risk

  1. 1. Risk Management The Need Alaleh Mani 2013
  2. 2. Definition and source of Risk Risk= Unexpected variable of price or earning. Business Risk:  Management decision making risk. Business Strategy risk Macroeconomic risk
  3. 3. Extreme Market Movement Events caused volatility which resulted in financial losses and raised the need for the Risk Management: 1971 Exchange rate broke 1973 Oil shock 1987 Black Monday 1989 Japanese bubble 1997 Asian contagion 1998 Russian default 2001 September 11 2007 Credit crisis
  4. 4. Globalization / Deregulation These two factors increased the importance of risk management: Deregulation in banks caused interest rate sensitivity. Globalization caused more exposure to currency exchange.
  5. 5. Some related definition  Derivatives: a zero sum game  Leverage: allow Derivatives to be a useful hedging instrument due to: 1. Limited initial cash outlay 2. low transaction cost.  Value at risk: Maximum of loss over time with at level of confidence. VAR is an statistical measure: 1. Historical VAR 2. Delta-normal VAR 3. Monte Carlo VAR
  6. 6. VAR  VAR is ex-ante measure  VAR is difficult to calculate  VAR is comparable across different business.  VAR is for risk budgeting
  7. 7. Other Risk management tools  Stop- loss limit: After loss occurred Co. eliminates the position to limit the loss. Ex-post ,Aggregated, easy to calculate.  Notional limits: limit the notional amount  Exposure limits: limit the risk factor though it is hard to calculate
  8. 8. Exposures: Factors fail to measure to qualify the volatility of factors and the correlation between them 1.Duration for interest rate :effect interest rate changes on bond price 2.Beta for Equity Market 3.Delta for Option
  9. 9. Valuation  The process of discounting future expected value of an asset to determine the current price  E(value)= mean of distribution of possible value VAR explain the future distribution.  Derivatives valuation : risk neutral pricing to prevent the persistence of arbitrage situations.
  10. 10. Types of Major Risk  Market Risk  Liquidity Risk  Credit Risk  Operational Risk
  11. 11. Market Risk  Price volatility in financial Market:  Absolute Risk: directly on return volatility  Relative Risk: tracking error the risk to a benchmark  Basic Risk: if hedging instrument doesn’t correlate with underlying asset
  12. 12. Liquidity Risk  Asset Liquidity Risk= Market Liquidity risk= trading liquidity risk when large transaction influence the price  Fundinig liquidity risk=cash flow risk when a financial institute is unable to raise cash to roll over its debt or ..
  13. 13. credit Risk  Credit risk: counterparty obligation default  Sovereign risk: country willingness to pay it obligation  Settlement risk counterparty default in paying obligation
  14. 14. Operational Risk  Model risk: loss due to misapplied model  People Risk: internal employee or external fraud  Legal risk: lawsuit, penalties, fines cause value loss  No reputational or strategic risk included

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