Chapter 27: Management of Market risk Flashcards
Key activities of market risk management RIC PL
• Reporting
• Implementing risk-portfolio strategies
• Capital management
• Policy setting and monitoring
• Limit setting and monitoring
Components of a market risk policy RAHR BEL
• Roles and Responsibilities
• Authority delegation
• Hedging policy PRET T
• Risk measurement and reporting MET C
• Back testing and valuation
• Exception management
• Liquidity policy
Components of a hedging policy PRET T
o Products and strategies to use
o Review triggers
o Effectiveness measures
o Type of risks to hedge
o Target level of hedging
Components of risk measurement and reporting MET C
o Metrics, methodologies, and reporting
o Escalation processes
o Timeliness of reporting
o Compare limits against metrics
Features of Exchange-traded derivatives SES CML
• Standardised
• Exchange traded
• Settled via a clearing house
• Clearing house takes on the counter-party risk
• Mitigations of counterparty risks in place: pooling, requiring margins or other collateral, marking to market
• Liquidity is high and low transaction costs
Main factors affecting price of OTC derivatives PITY C
• Price of underlying (current spot price)
• Interest rate changes expected
• Time to delivery
• Yield income expected on the underlying
• Counterparty risk
Causes basis risk in future/forward trading CUEDE CD
• Closing position before expiry date
• Underlying and actual asset may differ
• Early expiry resulting in roll over of future
• Date of purchase of underlying is uncertain
• Exclusions on the derivative – income and cost
• Demand for the derivative
• Capital requirements of derivative vs asset
Merits of hedging with derivatives CEO ICU
• Cheaper to deal with derivative than underlying
• Easily change exposure to asset
• Other risk exposure may increase
• Ineffective to manage risk
• Complex and time consuming to trade
• Upside risk eliminated
Challenges with dynamic hedging: PLADIL
• Practical challenge with continuous rebalancing
• Large number of derivatives required
• Availability of derivatives
• Dealing costs incurred
• Individual assets vs portfolio difficult to achieve
• Liquidity constraints
Shortfalls in immunisation RISA
Rebalancing required
Interest rate change protection only
Small interest rate changes catered for
Amount and timing of L cashflows not matched
Dynamic hedging definition DODO
• Day-to-day hedging via assets, derivatives
• Offsetting transactions found – forward contracts
• Delta neutrality is the aim
• Option writers apply the strategy
Managing interest rate risk FC HIMS
• Futures rate agreement (swap in future, fixed principle amount, varying interest rate structures, net off of payments)
• Caps and floors (OTC interest rate option - insurance on interest rates falling or rising above certain levels)
• Hedging at model points (ensure key cashflows are hedged)
• Immunisation PV Mean term Convexity
• Matching cashflows CANT
• Swaps
