The document discusses risk and derivatives. It defines risk as the possibility of an adverse outcome from a situation. It also discusses different types of risk like objective and subjective risk. It then explains key concepts related to derivatives like forwards, futures, options, and swaps. It discusses the purpose, features and risks associated with these derivative products. Finally, it briefly outlines the different participants in the derivatives market like hedgers, speculators, arbitrageurs etc.

1. RISK
Risk is a condition in which there is a
possibility of an adverse deviation from a
desired outcome that is expected or
hoped for

2. Risk may objective or subjective


Objective risk: relative variation of actual loss
from expected loss.
Subjective risk: uncertainty based on a
persons mental condition or state of mind.

3. In risk two elements are commonly
found


The outcome is uncertain.
There are at least two possible outcome for
given situation .
Out of the possible outcome ,one is
unfavorable.

4. Risk v/s uncertainty




Uncertainty refers to a situation where the
outcome is not certain or unknown.
Uncertainty refers to a state of mind
characterised by doubt, based on the lack of
knowledge about what will not happen in the
future.
Risk refers to a situation where there is
possibility of a loss
Loss means that portion of expired cost for
which no compensating value has been
received

5. Perils and hazards




Cause of loss or the contingency that may
cause a loss.
Hazards are the condition that increase the
severity of loss or the condition affecting peril.
Physical hazards: Property
conditions.eg.stocking crackers
Intangible hazards: attitudes and culturepsychological nature.

6. Intanigible hazards



Moral hazard:Fraud eg.putting fire to a factory
running in losses.
Moral hazard: indifference-it is the attitude of
indifference to take care of the property on the
premises that the loss will be indemnified by
the insurance contract
Societal hazards: legal and cultural-these refer
to the increase in the frequency and severity of
loss arising from legal doctrines or social
customs and structure.

7. Types of Risk





Financial and non-financial risk
Individual and group risks
Pure and speculative risk
Static and dynamic risk
Quantifiable and non-Quantifiable risk

8. Risk Management

Risk mean that some danger or loss may be
involved in carrying out an activity and
therefore,care has to be taken to avoid that
loss.

9. definition

Risk management is an interated process of
delineating specific areas or risk, developing a
comprehensive plan, integrating the plan,and
conducting ongoing evaluation.

10. The process





Defining the objectives of the risk
management exercise.
Identifying the risk exposures
Evaluating the exposures
Critical analysis of risk management
alternative and selecting one of them
Implementation and review

11. Risk mgmt. into three elements
Risk Analysis
 Risk control
 Risk financing
Risk management process has a necessity to
be dynamic. Therefore continuous
reassessment and monitoring of the results.


12. Prevention is better than cure


Risk identification: the first step in the process
is to anlalyse the risk. Risk analysis has two
prime elements-the identification of risk and its
evaluation.
Risk identification requires knowledge of the
org.,mkt. in which it operate,the
legal,social,economic,political

13. Risk evaluation


The probability of loss occuring
Its severity

14. Risk control


Risk control covers all those measures aimed
at avoiding ,eliminating or reducing the
chances of loss-producing events occurring or
limiting the severity of losses that do happen.
Risk can be controlled either by avoidance or
by controlling losses.

15. Before occurrence of losses



Reduction in worry and fear
Economical ways of handing risk
Overcome legal obligations

16. After occurrence of lossses



Survival
Congruence with mission and objectives
Optimising social effects

17. Risk financing




Risk exposure for an organisation exceeds the
maximum limit that the org. can bear,it
becomes necessary to either transfer or
reduce risk
Cost involved in both
Insurance is method adopted
In long run an org. will have to pay for its own
losses

18. 




The primary objective of risk financing is to
spread more evenly over time cost of risk in
order to reduce the financial strain and
possible insolvency.
It can finance in three ways
Losses may be charge as they occur to current
operating cost
Provision may be made through purchase of
insurance.
Finaced through loans

19. Risk retention



It implies the losses arising due to a risk
exposure shall be retained or assumed by the
party or the org.
Self insurance
Captive insurance

20. Risk transfer


Insurance
Non-insurance

21. Risk management by
individuals
A)
Identification of potential losses:
Personal risk
Property risk
liability risk

22. Evaluation of potential losses


Estimating the frequency and severity of
losses
Eg. The chance that your home will be totally
destroyed by certain natural calamity

23. Selecting the appropriate
techniques for handling losses
Loss of control: it is method by which
frequency and security of losses are controlled
Eg.locking of car ,wearing helmet
2. avoidance:
3. Retention:
Active Risk Retention
Passive risk retention
4. Non insurance: Defective music System
5.Insurance


24. Review the programe

To find out deviations,significant,modification

25. Factors affecting individual’s
demand for insurance





Price for risk transformation
Perception towards losses
Income and wealth states
Social insurance programs
Nature of losses

26. Process of risk management by
individual
1.Identifying potential losses.
2. Evaluating Potential losses.
3.Selecting the Appropriate Technique.
a) Avoidance
b) Risk control
c) Risk Retention
d) Non-insurance transfers
e) Insurance
4.Periodic Review

27. Personal Risk Management
Strategies


Should ensure that assets are protected and
debts are cleared in the event of the
unforeseen death, major accident or major
illness of a key financial members.
There are four key forms of personal
protection insurances

28. Life term insurance



Known as Term Insurance
It pays lump sum benefit to the policy owner
upon death of the life insured
Is used to repay liabilities, such as mortgage,
credit cards etc.

29. Total & Permanent Disability (TPD)
insurance


TDP insurance provides a lump sum upon
medical confirmation that the insured person is
totally and permanently disabled based on the
definition provided in the policy document.
Usually sold as additional benefit

30. Trauma (Critical illness)
Insurance

Trauma insurance pays you a lump sum in the
event of a major trauma such as a major heart
attact, cancer or stroke.

31. Income protection insurance

Income protection cover is designed to provide
you with a regular monthly income while you
cannot work due to sickness or accident.

32. Risk Management objective


a)
b)
Risk management is broader concept than
insurance management and includes all
techniques for treating loss exposure ,in
addition to insurance.
It has impt. objective
Pre-loss objective
Post loss objective

33. Pre loss objective



Reduction in worry and fear
Economy
Meeting legal obligation

34. Post loss objective





Survival
Continued operation
Stability of earning
Continued growth
Optimizing social effects

35. Levels of Risk management
Risk management operate at three levels
1.Time-critical:time critical process of risk
management is employed by personnel to
consider risk while making decisions in a timecompressed situation

36. Deliberate



Is application of the complete process.
It uses experience and brainstorming to
identify risk.
Planning of upcoming operations,review of
standard operating ,maintenance or training
procedures and damage control or disaster
response planning.

37. strategic

It is process with more through hazard
identification and risk assessment involving
research of available data, use of diagram and
analysis tools,formal testing or long term
tracking of the risks associated with the
system or operation.

38. Risk management and
Derivatives





The term derivative indicate that it has no
independent
value
Its value is entirely derived from the value of the
value of the underlying asset
Securities, commodities, bullion, currency,live
stock.
Derivative means a forward, future, option or any
other hybrid contract of pre determined fixed
duration,linked for the purpose of contract
fulfillment to the value of a specified real or
financial asset or to an index of securities.

39. Derivative markets classified


Commodity derivative market:
wheat, cotton,pepper,chana or precious metals
like gold,silver.
Financial derivative: equity,interest rates and
exchange rate.

40. Types/classification of
Derivatives




Forwards
Futures
Options
Swaps

41. Forward Contract



Two parties agree to do a trade at some future
date, at a price and qty. agreed today.
No money changes hands at the time the deal
is signed.
Agreed price is called forward price with a
forward market the transfer of ownership
occurs on the spot,but the delivery of the
commodity or instrument does not occur until
some future date

42. Features of forward contracts




They are bilateral contracts and hence
exposed to counter-party risk.
Each contract is custom designed, and hence
is unique in terms of contract size, expiration
date and the asset type and quality.
The contract has to be settled by delivery of
the asset on expiration date.
The party wishes to reverse the contract, it has
to compulsorily go to the same counter party.

43. Future contract



Future contract means a legally binding
agreement to buy or sell the underlying
security on a future date.
Future contract are the organized/standardized
contracts in terms of quantity,quality(in case of
commodities), delivery time and place for
settlement on any date in future.
The contract expires on a pre-specified date
which is called the expiry date of the contract.

44. 


On expiry, future can be settled by delivery of
the underlying asset or cash.
Cash settlement enables the settlement of
obligations arising out of the the future/option
contract in cash.
The agreed upon price is called the future
price

45. Features of a futures contract


Use of standard contracts:standardization of
the contracts fetches the potentials buyers and
sellers and increases the marketability and
liquidity of the contracts.
Clearing House: Future exchange will act as a
clearing house. In future contract the obligation
of the buyer and the seller is not to each other
but to the clearing house in fulfilling the
contract which eliminates default risk.

46. 


Margin requirements: 5% to 10% o face value
Time spreads: relation between spot price and
future price of the contract. The relationship
exists between prices of future contracts which
are on same commodity or instrument but
which has different expiry dates. The
difference between the prices of two contracts
is known as the time spread.
Simple pay off possitions in future: either
positive or negative.

47. Options Contracts


Gives the buyer/holder of the contract the right
(but not the obligation) to buy/sell the
underlying asset at a predetermined price
within or at end of a specified period.
The buyer of the option purchases the right
from the seller/writer for a consideration which
is called the premium.

48. European and American option
If an option that is exercisable on or before the
expiry date is called American option.
 The holder can exercise the right anytime
between purchase date and expiration date.
European option
 An option that is exercisable only on expiry
date is called European option.
 The price at which the option is to be
exercised is called strike price or Exercise
price.


49. Call and Put option

Call Option: A call option is the right (not the
obligation) to buy the commodity or security at
a specific price called the exercise price.

50. Call
Buyer
Holder
long
Seller
Writer
Short
Has the right but not the obligation
to buy 100 shares of the underlying
stock at the strike price
Is obliged on demand, to sell 100
shares of the underlying stock at the
strike price when the holder
exercises
Pays the total
Premium
Receives the
total premium

51. Expectations, rewards and risks of
holder and writer of a call option
Call
Buyer
Holder
long
Expectation: Wants the market price
of the underlying stock to rise.
Reward: Potentials unlimited gain
when the price of the underlying stock
appreciates
Risks: Losses only the total premium
paid for the call when the market
price of underlying stock declines.
Seller
Writer
Short
Expectation: Wants the market price
of the underlying stock to decline.
Reward: gain limited to the total
premium received when the option
was written
Risks: Losses only the total premium
paid for the call when the market
price of underlying stock rises.

52. Put
Buyer
Holder
long
Seller
Writer
Short
Has the right but not the obligation
to sell100 shares of the underlying
stock at the strike price
Is obliged on demand, to buy 100
shares of the underlying stock at the
strike price when the holder
exercises
Pays the total
Premium
Receives the
total premium

53. Expectations,rewards & risks of
holder and writer of a put option
Call
Buyer
Holder
long
Expectation: Wants the market price
of the underlying stock to decline.
Reward: Maximum profit when the
price of the underlying stock declines
to Zero.
Risks: Losses only the total premium
paid for the call when the market
price of underlying stock rises.
Seller
Writer
Short
Expectation: Wants the market price
of the underlying stock to rise.
Reward: Gain limited to the total
premium received when the option
was written
Risks: Losses more and more as the
stock price declines lower and lower.

54. Swap Contract




A swap is a derivative,where two
counterparties exchange one stream of cash
flows against another stream.
These streams are called the legs of the swap.
Used to hedge certain risks
Swaps are OTC derivatiive

55. Commonly used swaps



Interest rate swaps: swapping only interest
related cash flows between the parties in
same currency
Currency swaps: swapping of both principal
and interest between the parties.
Swaption: Swaption are options to buy or sell
a swap that will become operative at the expiry
of the options. Thus a swaption is an option on
a forward swap.

56. Need



Transfer risk
Reflects the perception
Discovery of Prices

57. Risk involved in derivatives
market





Credit Risk
Market Risk
Liquidity Risk
Legal Risk
Operating Risk

58. Participants in the Derivative
Markets






Hedgers:
Speculators:
Arbitrageurs:
Day traders:
Floor Trader:
Market maker: