Treasury risks


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Treasury risks

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Treasury risks

  2. 2. TREASURY RISKS1. Interest rate risk2. Foreign exchange risk3. Credit risk4. Commodity risk5. Operational risk6. Liquidity risk7. Other risks
  3. 3. INTEREST RATE RISK1. Absolute interest rate risk2. Yield curve risk3. Reinvestment or refunding risk4. Embedded options risk
  4. 4. • Absolute interest rate risk – It arises from exposure to a directional (up or down) change in interest rates
  5. 5. Yield Curve Risk• Arises from changes in the relationship between ST and LT interest rates• Usual shape of yield curve is upward sloping• Steepening or flattening or becoming downward sloping changes the relationship• The change in shape changes the interest rate differential b/w ST and LT maturities• It impacts borrowing and lending decisions and therefore profitability
  6. 6. Foreign Exchange Risk• Transaction Risk• Translation Risk• Strategic Risk
  7. 7. Forex – Transaction Risk• Arises from transactions reported in the income statement of a company• Result of purchases/payments in Forex• Inventories, royalties, license fees, etc• Sales in forex
  8. 8. Forex – Translation Risk• It arises when assets, liabilities or profits are translated from the operating currency into a reporting currency• For example the reporting currency of a parent company
  9. 9. Translation Risk - Example US $ in UK Pound UK Pound millions Sterling@ Sterling @ 1.60 in 1.50 in millions millionsGross 1,000 625 667AssetsLiabilities 250 156 167Net 750 469 500AssetsNet 150 97 103Profit
  10. 10. Credit Risk• Default risk• Counter party risk• Sovereign or country risk• Concentration risk• Legal risk – Arises from a possibility that a counter party is not legally permitted to enter into transactions such as derivatives transactions
  11. 11. Commodity Risk• Commodity price risk• Commodity quantity risk• Issues – Quality – Delivery – Location – Transportation – Spoilage – Shortages, storability
  12. 12. Operational Risk• Human Errors and Frauds• Processes and procedural risk – Eg. Use of inadequate controls – Sarbanes-Oxley act in USA• Technology and systems risk – Weakness in technology and systems provide opportunities for errors, failures, lost data and fraud
  13. 13. Liquidity Risk• The ability of a firm to maintain adequate liquidity through Wrk. Cap. Mgt.• Firm’s capacity to meet its ST obligations• Ability to buy securities• Ability to sell securities• Ability to close out contracts; trading/hedging• The less liquid a market, the more costly and difficult to undertake transactions in the mkt.
  14. 14. Other Risks• Basis risk• Reputation risk• Equity price risk• Systemic risk – Failure of a major financial institution could trigger a domino effect – Can also arise from technological failure or a major disaster
  15. 15. Risk Measurement• Two approaches for risk management – Day to day or Tactical standpoint – High level or Strategic view• It is necessary to have the capability to monitor risk from both stand points• Risk management requires both quantitative and qualitative analysis• However it cannot be reduced to a simple – Checklist, a mechanical process or a number
  16. 16. Risk Measurement• Risk assessment is a two part process – Assessment of likely gain or loss from changes in market rates or prices – Assessment of probability of the changes
  17. 17. Sensitivity• Calculate net exposure taking into account various positions of the organization• Example – Exposure to foreign currency – Track all assets, liabilities, expenses and revenues in a foreign currency – Study fluctuations when exchange rate changes – GAP Analysis
  18. 18. Scenario Analysis• Also called “ What – If – Aanlysis• Its assesses potential loss by analyzing the value of an instrument or a portfolio under different scenarios• One factor scenarios such as interest rates• Multifactor scenarios such as changes in interest rates as well as changes in foreign exchange rates
  19. 19. Scenario Analysis• Assess performance of a portfolio of bonds• Portfolio performance might be assessed under differing differing yield curves – Parallel shift with rising interest rates – Parallel shift with declining interest rates – Steepening of the yield curve – Flattening of the yield curve – Scenario with an inversion to part or all of the yield curve
  20. 20. Stress Testing• Assessment of how exposure might perform under more extreme conditions• It may involve changing one or more variables using major historical price changes• If test shows unmanageable potential losses• Strategies can be formulated to deal with them• Proper preparation is the key
  21. 21. Value at Risk• The most commonly used measure of market risk• It is a systematic methodology to estimate the potential financial loss for a given period of time• It is based on statistical estimates of probability at a pre-determined confidence interval
  22. 22. Value at Risk• An estimate of the probability of a loss being greater than or less than a particular $ amount as a result of market fluctuations• It is commonly used for portfolios of assets or for exposures
  23. 23. Credit Risk Measurement• Assessment of probability of counter party defaulting on its financial obligation• Exposure at counter party default• Loss given counter party default which considers recovery of amounts that reduces the loss otherwise resulting from default• Counter party ratings (credit ratings)
  24. 24. Credit Risk Measurement• Notional Exposure – Notional or contractual or nominal amounts outstanding sometimes cited as amounts at risk – In certain derivatives transactions, less than notional amount may be at risk – Full contractual amount is potentially at risk during settlement• Aggregate Exposure
  25. 25. Replacement Cost• The cost to replicate a transaction at current market prices• Assuming no settlement failures if the derivatives counterparty defaulted on its obligations
  26. 26. Operational Risk – Defined by BIS 2003• Internal Fraud• External Fraud• Employment Practices• Workplace Safety• Clients• Products• Business Practices• Damage to Physical Assets• Business Disruption & System Failures
  27. 27. Operational Risk Measurement• It results from an organization’s exposure to people, processes and systems• Such risk management attempts to reduce probability of loss resulting from frauds or errors• Operational risk databases are being used to measure and manage operational risk
  28. 28. Operational Risk• Potential for operational risk include – Number of deviations from policy or stated procedures – Comments and notes from internal or external audits – Levels of staff turnover – Volatility of earnings – Unusual complaints from customers and vendors – Volume of derivatives trade
  29. 29. Operational Risk – Example TSE 2005• During the initial public offering of J-Com on December 8, 2005, an employee at Mizuho Securities Co., Ltd. mistakenly typed an order to sell 610,000 shares at 1 yen, instead of an order to sell 1 share at 610,000 yen.• Mizuho failed to catch the error; the Tokyo Stock Exchange initially blocked attempts to cancel the order, resulting in a net loss of 347 million US dollars to be shared between the exchange and Mizuho.
  30. 30. Operational Risk – Example TSE 2005• Both companies are now trying to deal with their troubles: lack of error checking, lack of safeguards, lack of reliability, lack of transparency, lack of testing, loss of confidence, and loss of profits.• On 11 December, the TSE acknowledged that its system was at fault in the Mizuho trade. On 21 December, Takuo Tsurushima, chief executive of the TSE, and two other senior executives resigned over the Mizuho affair.