Inhoudsopgave
1 Chapter: What is Financial Risk Management?....................................................................6
1.1 What is Risk?................................................................................................................. 6
1.2 How does Financial Risk Arise?.....................................................................................6
1.3 What is Financial Risk Management?............................................................................6
1.4 Diversification................................................................................................................ 7
1.5 Risk Management Process............................................................................................7
1.5.1 Step1: Establish the context....................................................................................7
1.5.2 Step 2: Identify the risks..........................................................................................8
1.5.3 Step 3: Analyse and evaluate the risks....................................................................8
1.5.4 Step 4: Treat the risks.............................................................................................8
1.5.5 Step 5: Monitor and review......................................................................................9
1.6 Factors that impact Financial Rates and Prices.............................................................9
1.6.1 Factors that affect interest rates..............................................................................9
1.6.2 Factors that affect foreign exchange rates..............................................................9
1.6.3 Factors that affect commodity prices.......................................................................9
1.7 Financial Risk Management: a selective history............................................................9
2 Chapter: Identifying major Financial Risks?.......................................................................10
2.1 Interest rate risk........................................................................................................... 10
2.1.1 Absolute interest rate risk......................................................................................10
2.1.2 Yield curve risk......................................................................................................11
2.1.3 Reinvestment or refunding risk..............................................................................11
2.1.4 Basis risk...............................................................................................................11
2.2 Foreign exchange risk..................................................................................................11
2.2.1 Transaction exposure............................................................................................11
2.2.2 Translation exposure.............................................................................................12
2.2.3 Foreign exchange exposure from commodity prices.............................................12
2.2.4 Strategic exposure................................................................................................12
2.3 Commodity risk............................................................................................................ 12
2.3.1 Commodity price risk.............................................................................................12
2.3.2 Commodity quantity risk........................................................................................12
2.3.3 Contango and backwardation................................................................................13
2.3.4 Commodity basis...................................................................................................13
2.3.5 Special risks.......................................................................................................... 13
2.4 Credit risk.................................................................................................................... 13
2.4.1 Default risk............................................................................................................ 13
, 2.4.2 Counterparty pre-settlement risk...........................................................................13
2.4.3 Counterparty settlement risk..................................................................................13
2.4.4 Sovereign or country risk.......................................................................................13
2.4.5 Concentration risk.................................................................................................13
2.4.6 Legal risk...............................................................................................................13
2.5 Operational risk............................................................................................................14
2.5.1 Human error and fraud..........................................................................................14
2.5.2 Processes and procedural risk..............................................................................14
2.5.3 Technology and systems risk................................................................................14
2.6 Other types of risk........................................................................................................14
2.6.1 Equity price risk.....................................................................................................14
2.6.2 Liquidity risk.......................................................................................................... 14
2.6.3 Embedded options................................................................................................14
2.6.4 Systemic risk.........................................................................................................14
3 Chapter: interest rate risk...................................................................................................14
3.1 Global cash netting......................................................................................................15
3.2 Intercompany lending..................................................................................................15
3.3 Embedded options.......................................................................................................15
3.4 Changes to payment schedules...................................................................................15
3.5 Asset-Liability Management.........................................................................................15
3.6 Forward rate agreements.............................................................................................16
3.7 Interest rate futures......................................................................................................16
3.8 Bond futures................................................................................................................ 16
3.9 Interest rate swaps......................................................................................................16
3.10 Interest rate options...................................................................................................16
4 Chapter: Foreign Exchange Risk........................................................................................16
4.1 Currency netting.......................................................................................................... 16
4.2 Proxy hedging.............................................................................................................. 16
4.3 Foreign currency debt..................................................................................................16
4.4 Changes to purchasing/ processing.............................................................................16
4.5 Transfer exchange rate risk.........................................................................................16
4.6 Forward contracts........................................................................................................16
4.7 Swaps.......................................................................................................................... 16
4.8 Currency futures.......................................................................................................... 16
4.9 Foreign exchange options............................................................................................16
5 Chapter: credit risk.............................................................................................................17
5.1 How credit risk arises...................................................................................................17
, 5.1.1 Default risk............................................................................................................ 17
5.1.2 Counterparty pre-settlement risk...........................................................................17
5.1.3 Counterparty settlement risk..................................................................................17
5.1.4 Legal risk...............................................................................................................18
5.1.5 Sovereign or country risk.......................................................................................18
5.1.6 Concentration risk.................................................................................................18
5.2 Credit exposure management......................................................................................18
5.2.1 Credit risk function.................................................................................................18
5.2.2 Diversification........................................................................................................19
5.2.3 Credit rationing......................................................................................................19
5.2.4 Collateral...............................................................................................................19
5.2.5 Netting agreements...............................................................................................19
5.2.6 Marking-to-market.................................................................................................19
5.2.7 Credit limits...........................................................................................................20
5.2.8 Contingent actions.................................................................................................20
5.2.9 Other credit risk management techniques.............................................................20
5.3 Credit derivatives......................................................................................................... 20
6 Chapter: commodity risk.....................................................................................................20
6.1 Historical references....................................................................................................20
6.2 Fixed-rate contracts.....................................................................................................20
6.3 Types of participants....................................................................................................20
6.4 Commodities markets..................................................................................................21
6.4.1 Metals................................................................................................................... 21
6.4.2 Agricultural commodities.......................................................................................21
6.4.3 Energy...................................................................................................................21
6.4.4 Other commodities................................................................................................21
6.5 Commodity forwards and futures.................................................................................21
6.6 Commodity options......................................................................................................21
7 Chapter: operational risk....................................................................................................22
7.1 How operational risk arises..........................................................................................22
7.1.1 Error and fraud......................................................................................................22
7.1.2 Processes and procedures....................................................................................22
7.1.3 Technology and systems.......................................................................................22
7.1.4 Operational considerations....................................................................................23
7.1.5 Internal controls.....................................................................................................23
7.1.6 Compensation of personnel...................................................................................23
7.1.7 Management involvement.....................................................................................23
, 7.1.8 Conflicts of interest................................................................................................23
7.1.9 Staff training and skills..........................................................................................24
7.1.10 Financial institution and vendor relationships......................................................24
7.1.11 Monitoring exposures..........................................................................................24
7.1.12 Communication and reporting.............................................................................24
7.1.13 Forecasts and reconciliations..............................................................................24
7.1.14 Risk oversight......................................................................................................24
7.1.15 Marking to market................................................................................................24
7.1.16 Policies................................................................................................................ 25
7.1.17 System considerations........................................................................................25
7.1.18 Professional assistance.......................................................................................25
7.2 Special issues in managing operational risk................................................................25
7.3 Industry recommendations...........................................................................................25
7.3.1 Group of 31: core principles..................................................................................25
8 Chapter: Risk Management framework: policy and hedging...............................................26
8.1 Risk profile of an organization......................................................................................26
8.1.1 Evaluating financial exposures..............................................................................26
8.1.2 To hedge or not to hedge......................................................................................26
8.1.3 Tolerance for risk (op EX).....................................................................................27
8.1.4 Acceptable risk exposure......................................................................................27
8.1.5 Competitive landscape..........................................................................................27
8.1.6 Board and management: role, requirements and challenges................................28
8.2 Risk management policy..............................................................................................28
9 Chapter: measuring risk.....................................................................................................28
9.1 Measures of exposure.................................................................................................28
9.1.1 How much can I lose?...........................................................................................28
9.1.2 Gap analysis (mismatch analysis).........................................................................28
9.1.3 Leverage and direction..........................................................................................28
9.1.4 Instrument sensitivity.............................................................................................28
9.1.5 Scenario analysis (what-if analysis)......................................................................29
9.1.6 Stress testing........................................................................................................ 29
9.1.7 Financial crises.....................................................................................................29
9.2 Value-at-risk................................................................................................................30
9.2.1 Methods to calculate value-at-risk.........................................................................30
9.2.2 Assumptions and limitations..................................................................................30
9.2.3 Value-at-risk using historical simulation.................................................................30
9.2.4 Value-at-risk using Monte Carlo simulation...........................................................31
1 Chapter: What is Financial Risk Management?....................................................................6
1.1 What is Risk?................................................................................................................. 6
1.2 How does Financial Risk Arise?.....................................................................................6
1.3 What is Financial Risk Management?............................................................................6
1.4 Diversification................................................................................................................ 7
1.5 Risk Management Process............................................................................................7
1.5.1 Step1: Establish the context....................................................................................7
1.5.2 Step 2: Identify the risks..........................................................................................8
1.5.3 Step 3: Analyse and evaluate the risks....................................................................8
1.5.4 Step 4: Treat the risks.............................................................................................8
1.5.5 Step 5: Monitor and review......................................................................................9
1.6 Factors that impact Financial Rates and Prices.............................................................9
1.6.1 Factors that affect interest rates..............................................................................9
1.6.2 Factors that affect foreign exchange rates..............................................................9
1.6.3 Factors that affect commodity prices.......................................................................9
1.7 Financial Risk Management: a selective history............................................................9
2 Chapter: Identifying major Financial Risks?.......................................................................10
2.1 Interest rate risk........................................................................................................... 10
2.1.1 Absolute interest rate risk......................................................................................10
2.1.2 Yield curve risk......................................................................................................11
2.1.3 Reinvestment or refunding risk..............................................................................11
2.1.4 Basis risk...............................................................................................................11
2.2 Foreign exchange risk..................................................................................................11
2.2.1 Transaction exposure............................................................................................11
2.2.2 Translation exposure.............................................................................................12
2.2.3 Foreign exchange exposure from commodity prices.............................................12
2.2.4 Strategic exposure................................................................................................12
2.3 Commodity risk............................................................................................................ 12
2.3.1 Commodity price risk.............................................................................................12
2.3.2 Commodity quantity risk........................................................................................12
2.3.3 Contango and backwardation................................................................................13
2.3.4 Commodity basis...................................................................................................13
2.3.5 Special risks.......................................................................................................... 13
2.4 Credit risk.................................................................................................................... 13
2.4.1 Default risk............................................................................................................ 13
, 2.4.2 Counterparty pre-settlement risk...........................................................................13
2.4.3 Counterparty settlement risk..................................................................................13
2.4.4 Sovereign or country risk.......................................................................................13
2.4.5 Concentration risk.................................................................................................13
2.4.6 Legal risk...............................................................................................................13
2.5 Operational risk............................................................................................................14
2.5.1 Human error and fraud..........................................................................................14
2.5.2 Processes and procedural risk..............................................................................14
2.5.3 Technology and systems risk................................................................................14
2.6 Other types of risk........................................................................................................14
2.6.1 Equity price risk.....................................................................................................14
2.6.2 Liquidity risk.......................................................................................................... 14
2.6.3 Embedded options................................................................................................14
2.6.4 Systemic risk.........................................................................................................14
3 Chapter: interest rate risk...................................................................................................14
3.1 Global cash netting......................................................................................................15
3.2 Intercompany lending..................................................................................................15
3.3 Embedded options.......................................................................................................15
3.4 Changes to payment schedules...................................................................................15
3.5 Asset-Liability Management.........................................................................................15
3.6 Forward rate agreements.............................................................................................16
3.7 Interest rate futures......................................................................................................16
3.8 Bond futures................................................................................................................ 16
3.9 Interest rate swaps......................................................................................................16
3.10 Interest rate options...................................................................................................16
4 Chapter: Foreign Exchange Risk........................................................................................16
4.1 Currency netting.......................................................................................................... 16
4.2 Proxy hedging.............................................................................................................. 16
4.3 Foreign currency debt..................................................................................................16
4.4 Changes to purchasing/ processing.............................................................................16
4.5 Transfer exchange rate risk.........................................................................................16
4.6 Forward contracts........................................................................................................16
4.7 Swaps.......................................................................................................................... 16
4.8 Currency futures.......................................................................................................... 16
4.9 Foreign exchange options............................................................................................16
5 Chapter: credit risk.............................................................................................................17
5.1 How credit risk arises...................................................................................................17
, 5.1.1 Default risk............................................................................................................ 17
5.1.2 Counterparty pre-settlement risk...........................................................................17
5.1.3 Counterparty settlement risk..................................................................................17
5.1.4 Legal risk...............................................................................................................18
5.1.5 Sovereign or country risk.......................................................................................18
5.1.6 Concentration risk.................................................................................................18
5.2 Credit exposure management......................................................................................18
5.2.1 Credit risk function.................................................................................................18
5.2.2 Diversification........................................................................................................19
5.2.3 Credit rationing......................................................................................................19
5.2.4 Collateral...............................................................................................................19
5.2.5 Netting agreements...............................................................................................19
5.2.6 Marking-to-market.................................................................................................19
5.2.7 Credit limits...........................................................................................................20
5.2.8 Contingent actions.................................................................................................20
5.2.9 Other credit risk management techniques.............................................................20
5.3 Credit derivatives......................................................................................................... 20
6 Chapter: commodity risk.....................................................................................................20
6.1 Historical references....................................................................................................20
6.2 Fixed-rate contracts.....................................................................................................20
6.3 Types of participants....................................................................................................20
6.4 Commodities markets..................................................................................................21
6.4.1 Metals................................................................................................................... 21
6.4.2 Agricultural commodities.......................................................................................21
6.4.3 Energy...................................................................................................................21
6.4.4 Other commodities................................................................................................21
6.5 Commodity forwards and futures.................................................................................21
6.6 Commodity options......................................................................................................21
7 Chapter: operational risk....................................................................................................22
7.1 How operational risk arises..........................................................................................22
7.1.1 Error and fraud......................................................................................................22
7.1.2 Processes and procedures....................................................................................22
7.1.3 Technology and systems.......................................................................................22
7.1.4 Operational considerations....................................................................................23
7.1.5 Internal controls.....................................................................................................23
7.1.6 Compensation of personnel...................................................................................23
7.1.7 Management involvement.....................................................................................23
, 7.1.8 Conflicts of interest................................................................................................23
7.1.9 Staff training and skills..........................................................................................24
7.1.10 Financial institution and vendor relationships......................................................24
7.1.11 Monitoring exposures..........................................................................................24
7.1.12 Communication and reporting.............................................................................24
7.1.13 Forecasts and reconciliations..............................................................................24
7.1.14 Risk oversight......................................................................................................24
7.1.15 Marking to market................................................................................................24
7.1.16 Policies................................................................................................................ 25
7.1.17 System considerations........................................................................................25
7.1.18 Professional assistance.......................................................................................25
7.2 Special issues in managing operational risk................................................................25
7.3 Industry recommendations...........................................................................................25
7.3.1 Group of 31: core principles..................................................................................25
8 Chapter: Risk Management framework: policy and hedging...............................................26
8.1 Risk profile of an organization......................................................................................26
8.1.1 Evaluating financial exposures..............................................................................26
8.1.2 To hedge or not to hedge......................................................................................26
8.1.3 Tolerance for risk (op EX).....................................................................................27
8.1.4 Acceptable risk exposure......................................................................................27
8.1.5 Competitive landscape..........................................................................................27
8.1.6 Board and management: role, requirements and challenges................................28
8.2 Risk management policy..............................................................................................28
9 Chapter: measuring risk.....................................................................................................28
9.1 Measures of exposure.................................................................................................28
9.1.1 How much can I lose?...........................................................................................28
9.1.2 Gap analysis (mismatch analysis).........................................................................28
9.1.3 Leverage and direction..........................................................................................28
9.1.4 Instrument sensitivity.............................................................................................28
9.1.5 Scenario analysis (what-if analysis)......................................................................29
9.1.6 Stress testing........................................................................................................ 29
9.1.7 Financial crises.....................................................................................................29
9.2 Value-at-risk................................................................................................................30
9.2.1 Methods to calculate value-at-risk.........................................................................30
9.2.2 Assumptions and limitations..................................................................................30
9.2.3 Value-at-risk using historical simulation.................................................................30
9.2.4 Value-at-risk using Monte Carlo simulation...........................................................31
