risk management
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Risk Management. By Niken Iwani Surya Putri . S.E.MSc . Agenda For Today. 1. Introduction 2. chairman, class rules 3. expectation 4. Introduction to subjects (14 class), Textbook: (Kit Sadgrove ) 5. Meeting 1: Introduction (Scale and Scope of Risk Management). - PowerPoint PPT PresentationTRANSCRIPT
Risk Management
ByNiken Iwani Surya Putri. S.E.MSc.
Agenda For Today
• 1. Introduction• 2. chairman, class rules• 3. expectation• 4. Introduction to subjects (14 class),
– Textbook: (Kit Sadgrove)
• 5. Meeting 1: – Introduction (Scale and Scope of Risk Management)
Syllabi for 14 meeting• 1. Risk Management Introduction• 2. Why are Financial Institution Special?• 3. Depository Institutions• 4. Non depository Institutions (Insurance, Finance
Companies)• 5. Non depository Institutions (Mutual Fund, Hedge Fund)• 6. Risks Faced By Financial Institutions• 7. Measuring Risks of Financial Institutions• MIDTERM EXAM
Syllabi for 14 meeting• 8. Interest Rate Risk • 9. Market Risk• 10. Credit Risk• 11. Liquidity Risk• 12. Operational Risk• 13. Managing Risk 1: ALMA,deposit insurance, capital
Adequacy• 14. Managing Risk 2: Hedging tools, loan sales, securitization
• Final EXAM
• Risk definition The Australian Standard 4360 on Risk Management :
“… the chance of something happening that will have an impact upon objectives. It is measured in terms of likelihood and consequences”
What is Risk?
Kids, don’t try this without properly know what risk is....
Am not a reckless person just a very confident person,
with insurance…
1) A logical and systematic step2) Steps in decision making,
comprehensive3) Opportunity Identification4) Avoiding or Minimizingloss5) Good management practice
What is risk Management?
A logical and systematic method in
to identify, analyze, treat, and monitoring potential risk in every
business activities.
What is RiskManagement?
A method for managers in using the best possible
source to manage resources.
What is risk management?
Risk management develop responses from any identified events such below:– Prevention– Impact mitigation– Risk transfer– Risk acceptance
How to handle risk
“Assist company in identifying potential risk that might threat the company,
by analyzing its type, source, occurrence, and severity levels.
Management may act promptly in order to minimize the risks”
What are the benefits?
The user?
• Finance and Investment
• Insurance• Health Care• Public
Institutions• Governments• International
Corporation/M
NC
• Effective Risk Management Skill
• Standardized process (International Risk Management process standards).
• An integral part in finance and banking• An integral part of business and daily
life
Risk Management’s Knowledge Are
Failure of a project to reach its objectives Client dissatisfaction Unfavorable publicity Threat to physical safety Mismanagement Fraud and deficiencies in financial
control Failure of equipment Breach of legal responsibility
Type of risks
Risk Management ModelsEstablish Board’s Philosophy on Risk
Management
Determine Key Risk Areas
Stakeholder’s Risk Acceptance Expectations
What Events can Create UnfavourableConsequences in Key Risk Areas
What Unfavourable Consequences can Occur
What are the Impacts of these
Assess Risk
Determine & Apply Risk ManagementTechniques
Monitor & Adapt Continuously
1. Determine Strategic Elements
2. Determine Exposure
3. Determine Risks & Apply Techniques
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Steps in the Risk Management Process
- Property loss exposures- Liability loss exposures- Business income loss exposures- Human resources loss exposures- Crime loss exposures- Employee benefits loss exposures- Foreign loss exposures
Type of Losses
Major loss exposures and techniques for handling the loss exposure include the following:
Physical damage to a bus in an accident
(can be handled by a commercial auto policy, by retention of part of all of the loss exposure, and by loss control activities to reduce the possibility of an accident)
Sues arising out of injuries to children in a bus accident
(can be handled by a commercial auto policy, by loss control such as a defensive driving course, and by avoiding hiring
drivers with poor driving records)
Suits arising out of bodily injury or property damage to other motorists or pedestrians
(can be handled by a commercial auto policy, by loss control such as a defensive driving course, and by avoiding hiring drivers with poor driving records)
Physical damage losses to the three garages from natural disasters or
other perils
(can be handled by a commercial property insurance policy and by retention of part of the exposure by a sizable deductible)
Loss of business income if the firm is unable to operate (can be handled by business income insurance that covers the loss of business income
and extra expenses that continue during the shutdown period and by loss control activities to reduce the
possibility of a loss)
Workers compensation claims if a bus driver or other employees are injured in a work-related accident
(can be handled by workers compensation insurance and by self-insurance)
Death or disability of a key executive
(can be handled by loss control, such as an annual physical exam, and by having other employees trained to take over the duties of the key executive)
Tools for recognizing loss exposures:
- Risk analysis questionnaires- Physical inspection- Flow charts (standard operating procedure)- Financial statements- Historical loss data
Sources of Risk s(Internal dan External):Commercial and StrategicEconomicContractualFinancialEnvironmentalPoliticalSocialProject InitiationProcurement Planning
Risk Analysis
Risk Analysis
Operational Risk Jurisdiction Risk Settlement Risk Systems Risk
Employee Risk Strategic Decision Risk
Purchasing Risk
Strategic Risk Regulatory Risk
Tax Risk Catastrophe Risk Currency Policy
Sales Risk Competition Risk
Elasticity Risk Predictive Risk
Physical Risk Physical Assets
Real Estate Manufacturing Process
Supply Chain
Liquidity Risk Funding Risk
Market Liquidity
Cpty/Credit Risk Default risk
Downgrading
Market Risk Price risk (int. rate, ccy,
equity, commodity) Curve risk Basis risk
Correlation risk Option specific risk
FinancialRisks
ENTERPRISE RISK PLATFORM
Risk Analysis
SEVERITY
Catastrophic
IV
HAZARD PROBABILITY
Critical
Moderate
Negligible
I
II
III
Frequent Likely Occasional Seldom Unlikely
A B C D E
ExtremelyHigh High
Medium Low
Risk Analysis
HighImpact
LowImpact
LowLikelihood
HighLikelihood
Moderate RiskMinor Risk
Major RiskModerate Risk
Lifecycle of Risk Management
Adoption MaturityRelatively
Slower Advancement
Operational Risk
Credit Risk
Market Risk
Liquidity Risk Asset/Liability Management
Level of Develop
ment
Evolution of Risk Decision Making
Focus on Revenue and Cost Management
Mark-to-market
Activity-basedcosting
Transferpricing
1980s
Value atRisk
Risk-adjustedperformance
PortfolioManagement
1990s
Focus on Risk Control (historical focus)
Shareholder ValueIntegrated Risk & Profitability
2000+
Fully integratedprofitability andrisk information
Forward-looking,not just static,
management tools
Beware of Risks,
but don’t be
phobia toward
Risks…
Competency needed: Business Risk Modelling Risk Analysis tools such as: Value
at Risk (VaR), Risk Simulation, RAROC.
Career choice
Risk Management in Finance and Banking
This is it, class.. For those who love math and stat.
You’ll be watching clip movie Inside Job (10 min)
• This movie is about the subprime mortgage (credit default swap)
• In risk management perspective, what might go wrong?
Famous Notation in
Finance and Banking Risk ManagementNotation List
Rev = Revenue C () = Probability of loss occurence(1 – C) = Confidence level = Normal Standard DeviationR = ReturnZ = Normal Distribution i j = Coefficient correlation i and j
39
Different Types of Risk
• Speculative risks: Those that offer the chance of a gain as well as a loss.
• Pure risks: Those that offer only the prospect of a loss.
• Demand risks: Those associated with the demand for a firm’s products or services.
• Input risks: Those associated with a firm’s input costs.
• Financial risks: Those that result from financial transactions.
• Property risks: Those associated with loss of a firm’s productive assets.
• Personnel risk: Risks that result from human actions.
• Environmental risk: Risk associated with polluting the environment.
• Liability risks: Connected with product, service, or employee liability.
• Insurable risks: Those which typically can be covered by insurance.
40
An Approach to Risk Management• Corporate risk management is the management of
unpredictable events that would have adverse consequences for the firm.
• Firms often use the following process for managing risks.Step 1. Identify the risks faced by the firm.Step 2. Measure the potential impact of
the identified risks.Step 3. Decide how each relevant risk
should be dealt with.
41
Techniques to Minimize Risk• Transfer risk to an insurance company by paying periodic
premiums.• Transfer functions which produce risk to third parties.• Purchase derivatives contracts to reduce input and financial
risks.• Take actions to reduce the probability of occurrence of
adverse events.• Take actions to reduce the magnitude of the loss associated
with adverse events.• Avoid the activities that give rise to risk.
42
Nature and Purpose of Trading in Financial Derivatives
• Financial risk exposure refers to the risk inherent in the financial markets due to price fluctuations.
• Hedging– Protect Value of Securities Held– Protect the Rate of Return on a Security Investment– Reduce Risk of Fluctuations in Borrowed Costs
• Speculating
43
Using Derivatives to Reduce Risk
• Commodity Price Exposure– The purchase of a commodity futures contract will allow a
firm to make a future purchase of the input at today’s price, even if the market price on the item has risen substantially in the interim.
• Security Price Exposure– The purchase of a financial futures contract will allow a
firm to make a future purchase of the security at today’s price, even if the market price on the asset has risen substantially in the interim.
44
Using Derivatives to Reduce Risk
• Foreign Exchange Exposure– The purchase of a currency futures or options contract will
allow a firm to make a future purchase of the currency at today’s price, even if the market price on the currency has risen substantially in the interim.
45
Risks to Corporations from Financial Derivatives
• Increases financial leverage
• Derivative instruments are too complex
• Risk of financial distress
Basics of VaR• Static VaR, Uncoditional variance
If FX is a random variable, observed in T period, expected FX is:
•Assuming FX is normally distributed, ( Z )
E (FX) =T
Σt =1
FX t
T
σ (FX) = Σ (FX – E(FX) 2
T - 1
( 1 )
( 2 )
Z = FX – E (FX)
σ (FX)
whichE ( Z ) = 0, σ ( Z ) = 1with P ( Z ) = 5%, maka Z = – 1,65
47
Derivative Securities
• Derivative: Security whose value stems or is derived from the value of other assets.
• Types of Derivatives– Forward– Futures– Options– Swaps
48
Forward Contracts
• An agreement where one party agrees to buy (or sell) the underlying asset at a specific future date and a price is set at the time the contract is entered into.
• Characteristics– Flexibility– Default risk– Liquidity risk
• Positions in Forwards– Long position– Short position
49
Futures Contracts• A standardized agreement to buy or sell a specified
amount of a specific asset at a fixed price in the future.
• Characteristics– Margin Deposits
• Initial margin• Maintenance margin
– Marking-To-Market– Floor Trading– Clearinghouse
50
Hedging with Futures
• Hedging: Generally conducted where a price change could negatively affect a firm’s profits.– Long hedge: Involves the purchase of a futures contract
to guard against a price increase.– Short hedge: Involves the sale of a futures contract to
protect against a price decline in commodities or financial securities.
– Perfect hedge: Occurs when gain/loss on hedge transaction exactly offsets loss/gain on unhedged position.
51
Option Contracts• The right, but not the obligation, to buy or sell a
specified asset at a specified price within a specified period of time.
• Option Terminology– Call option versus put option– Holder versus writer or grantor– Exercise or strike price– Option premium– American versus European option
• Market Arrangements
52
Swap Contracts• Financial contracts obligating one party to exchange
a set of payments it owns for another set of payments owed by another party.– Currency swaps– Interest rate swaps
• Usually used because each party prefers the terms of the other’s debt contract.
• Reduces interest rate risk or currency risk for both parties involved.
VaR•The problem is, E(FX) and σ (FX) as other financial data, most likely is not normally distributed.
• Covariance and Correlation If X1 and X2 is two random variable, the joint distribution could show correlated activity between FX, and for example interest rate (i).
Kovariance = E ( X1 – E (X1) (X2 – E (X2) ) ( 3 )
σ12 =
1T - 1
ΣT
T = 1( X1t – E (X1) ) ( X2t – E (X2) ) ( 4 )
Correlation = , ( 5 )σ12
σ1 σ2
1 1
VAR PORTOFOLIO
( 6a )VARP = - P W
σ() = Σ 2iW σ +2
1Z Σ Σ Wi Wj σiσj ij (6b)
Security risk, Daily EAR
DEaR = σ2 (Δ)
= σ2 δ σA1
ΔA1 + δ σA2
ΔA2
1
2
= ( W Ω W1)
1
2
( 7 )
W = δ δA1
δ δA2
: ( 8 )
Ω = Var (ΔA1) Cov (ΔA1ΔA2)
Cov (ΔA1ΔA2) Var (ΔA2) ( 9 )
1
2
EWMAThis approach assumes that today’s return is affected by yesterday’s return (or some prior certain period) . The model is been used by JP Morgan by assuming mean of historical series is considered as 0 . So the model below only represent variances.
Ft+1\t = Ft\t – 1 + (1 - ) Xt (1 - ) =
Ft+1\t = (Ft-1\t – 2 + Xt-1) + Xt = 2Ft-1\t – 2 + Xt-1) + Xt = 2 (Ft-2\t – 3 + Xt-2) + Xt-1 + Xt = 3 Ft-2\t – 3 + 2Xt-2 + Xt-1 + Xt
Ft+1\t = q Xt – q + q - 1 Xt – (q – 1) + ......... 3Xt – 3 + 2 Xt – 2 + Xt – 1 + Xt
Ft+1\t = i Xt-i
q
i = 0
2 = ( 1 - ) t-1 ( rt – E (r) ) T
t = 1
"It is not the strongest species that survive,nor the most intelligent,
but the ones most responsive to change…" Charles Darwin
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