jun-00 risk management zvi wiener 02-588-3049 mswiener/zvi.html tools for risk management
TRANSCRIPT
Jun-00 Risk Management
Zvi Wiener
02-588-3049http://pluto.mscc.huji.ac.il/~mswiener/zvi.html
Tools for risk management
Jun-2000 slide 2Risk Management Tools
Tools Measurement tools
Financial tools
– options
– forwards, futures
– swaps
– insurance
Outsourcing
Jun-2000 slide 3Risk Management Tools
Senior Management
Marketing Finance Supply
Cashflow
Capital
Jun-2000 slide 4Risk Management Tools
Important Principles
Distinction between risk taking and risk control.
Backtesting.
Transparent reporting.
Timing is more important then precision!
Jun-2000 slide 5Risk Management Tools
Basic decisions
Goal of Risk Management
Base currency
Time horizon (embedded options)
Economic or Accounting approach
Admissible risk
Stop losses or other actions
Jun-2000 slide 6Risk Management Tools
Risk Management System 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
Can NOT
Jun-2000 slide 7Risk Management Tools
Measurement Tools CATS, CARMA $400K/yr Algorithmics, Risk Watch >$1M Infinity >$1M J.P. Morgan, FourFifteen $25K/yr FEA, Outlook $18K Risk Manager, RMG $30K/yr Theoretics, TARGA $75K Bankers Trust, RAROC $50K/run INSSINC, Orchestra $25-75K
Jun-2000 slide 8Risk Management Tools
Definition
VaR is defined as the predicted worst-case
loss at a specific confidence level (e.g. 99%)
over a certain period of time.
Jun-2000 slide 9Risk Management Tools
-3 -2 -1 1 2 3
0.2
0.4
0.6
0.8
1
Profit/Loss
VaR
1% VaR1%
Jun-2000 slide 10Risk Management Tools
Benchmarking
Financial assets– create an imaginary portfolio and measure performance relative to this portfolio.
Industry– measure relative to competitors.
Jun-2000 slide 11Risk Management Tools
Financial Tools
Options
Futures/Forwards
SWAP
FRA
Insurance
Jun-2000 slide 12Risk Management Tools
Derivatives
Contracts that are priced according to underlying variables (prices are derived from underlying).
Options, Futures, Forwards, Swaps, Warrants, etc.
Jun-2000 slide 13Risk Management Tools
Derivatives
Contingent claims
gold shipped
KTUBA
insurance
an option not to undertake a project
an option to leave
an option to change price
Jun-2000 slide 14Risk Management Tools
Financial Tools
Options
Futures/Forwards
SWAP
FRA
Insurance
Jun-2000 slide 15Risk Management Tools
Forward and Futures
Forward agreement
Futures - standard traded contracts
– margin
– mark to market
Final result is very similar
– settlement risk
Jun-2000 slide 16Risk Management Tools
Forward payoff
Forward at maturity
Underlying asset
Jun-2000 slide 17Risk Management Tools
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!
Jun-2000 slide 18Risk Management Tools
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?
Jun-2000 slide 19Risk Management Tools
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.
Jun-2000 slide 20Risk Management Tools
Forward Price
TUSD
TNIS
r
rSF
)1(
)1(
Jun-2000 slide 21Risk Management Tools
Hedge using ForwardCurrent 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 $100.
Forward price is 4.00*1.1/1.06=4.15.
The time match is important!
Jun-2000 slide 22Risk Management Tools
After a year$ Forward Your balance
3.9 25 3.9*100-410+25= 5
4.0 15 4.0*100-410+15= 5
4.1 5 4.1*100-410+ 5 = 5
4.2 -5 4.2*100-410- 5 = 5
4.3 -15 4.3*100-410-15 = 5
Complete protection with no cost!
Jun-2000 slide 23Risk Management Tools
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.
Jun-2000 slide 24Risk Management Tools
Marking to Market
Your balance
time
Maint.margin
margin call
Initialmargin