Presentation is loading. Please wait.

Presentation is loading. Please wait.

Jun-00 Risk Management Zvi Wiener 02-588-3049 Tools for risk management.

Similar presentations


Presentation on theme: "Jun-00 Risk Management Zvi Wiener 02-588-3049 Tools for risk management."— Presentation transcript:

1 Jun-00 Risk Management Zvi Wiener 02-588-3049 http://pluto.mscc.huji.ac.il/~mswiener/zvi.html Tools for risk management

2 Risk Management Tools Jun-2000 slide 2 Options F Call, Put F European, American F Strike, volatility, time to maturity F In-the-money, Out-of-the-money F Black-Merton-Scholes F OTC and Exotic options

3 Risk Management Tools Jun-2000 slide 3 Call Value before Expiration E. Call XUnderlying premium

4 Risk Management Tools Jun-2000 slide 4 Put Value before Expiration E. Put XUnderlying premium X

5 Risk Management Tools Jun-2000 slide 5 Other Options F Callable bond F Warrants F Asian, Bermudian, Digital F Real options – to start a new project – to change prices – to close some divisions

6 Risk Management Tools Jun-2000 slide 6 Hedge Ratio = Delta F Delta measures sensitivity of a position relative to a risk factor. F Similar to duration for bonds. F Delta of a call option is … F Delta of a put option is...

7 Risk Management Tools Jun-2000 slide 7 Call Delta E. Call S current value

8 Risk Management Tools Jun-2000 slide 8 Put Delta E. Put S current value

9 Risk Management Tools Jun-2000 slide 9 What type of risk protection would you suggest for a pension fund? payoff Stock market floor Buy index Buy put Sell calls

10 Risk Management Tools Jun-2000 slide 10 Buy stock Sell call Result Buy put

11 Risk Management Tools Jun-2000 slide 11 UPC example F Aug 98, a $90M convertible loan to UPC F Feb 99, $49M paid for 1.55M shares (10%) F The share price rose to $162 (5 times) F Four options were used to protect the value

12 Risk Management Tools Jun-2000 slide 12 UPC example F Buy 2 put options maturing 06-Feb-2002 – put option for 500,000 shares, strike $125 – put option for 300,000 shares, strike $153 F Sell 2 call options maturing 06-Feb-2002 – call option for 500,000 shares, strike $173 – call option for 300,000 shares, strike $212

13 Risk Management Tools Jun-2000 slide 13 UPC 125153173212UPC share 108 150 After tax capital gain is between $53M and $80M These options cover 800,000 shares only.

14 Risk Management Tools Jun-2000 slide 14 How much did it cost? F The results are not precise and very sensitive to volatility – if volatility is 10%$6.5M – if volatility is 20%$10M – if volatility is 30%$13M – if volatility is 40%$15M This is the amount the bank should pay to DASKASCH!

15 Risk Management Tools Jun-2000 slide 15 Risk Management Issues F Why only half of the bond was called? F Why only 800,000 shares were protected? F How to choose the protection level? F When does it make sense to hedge?

16 Risk Management Tools Jun-2000 slide 16 Butterfly 2*Call(550)-Call(540)-Call(560) payoff 540550560Stock market

17 Risk Management Tools Jun-2000 slide 17 Hedge using Forward Current exchange rate 4.00 USD interest rate6% 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!

18 Risk Management Tools Jun-2000 slide 18 After a year $ForwardYour balance 3.9253.9*100-410+25= 5 4.0154.0*100-410+15= 5 4.1 54.1*100-410+ 5 = 5 4.2-54.2*100-410- 5 = 5 4.3-154.3*100-410-15 = 5 Complete protection with no cost!

19 Risk Management Tools Jun-2000 slide 19 What if there is no perfect time match? F 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. F Do it very carefully! F Or better use OTC, but check prices.

20 Risk Management Tools Jun-2000 slide 20 Hedge using Options Current exchange rate 4.00 USD interest rate6% NIS interest rate 10% In a year you will receive $100 and will have to pay 410 NIS. Buy a put option with strike 4.1 for $100. The time match is important!

21 Risk Management Tools Jun-2000 slide 21 After a year $Put Opt.Your balance 3.9203.9*100 - 410 + 20= 0 4.0104.0*100 - 410 + 10= 0 4.1 04.1*100 - 410 + 0 = 0 4.2 04.2*100 - 410 - 0 =10 4.3 04.3*100 - 410 - 0 =20 Protection with some cost! The initial cost of options.

22 Risk Management Tools Jun-2000 slide 22 Example Your company has stable yearly income of 8M (shekels) a year and yearly costs of $1M and 1M Euro. For simplicity assume that all payments are on the end of ech calendar year. How to measure and to manage this risk?

23 Risk Management Tools Jun-2000 slide 23 Example Time horizon – 1 year Basic currency – SHEKELS Major risk factors – exchange rates USD, EUR and interest rates (for all 3 currencies). The present value of the next cashflow is:

24 Risk Management Tools Jun-2000 slide 24 Example Assume that now USD = 4 SHEKELS EUR = 3.5 SHEKELS r NIS = 10% r USD = 6% r EUR = 5%

25 Risk Management Tools Jun-2000 slide 25 Example The current value of the position is 165,809 NIS. But this number is subject to the risk factors. We ignore in this example the interest rates for simplicity.

26 Risk Management Tools Jun-2000 slide 26 Example Each time the USD/NIS rate increases by 1 AGORA, our position loses 9,434 NIS. Each AGORA in Euro exchange rate causes a loss of 9,524 NIS. Assume that yearly volatility of USD/NIS is 10%, and EUR/NIS is 20%. Correlation between them -0.1.

27 Risk Management Tools Jun-2000 slide 27 Example

28 Risk Management Tools Jun-2000 slide 28 Example The best way to hedge this risk is by forward contracts that will allow you to exchange the appropriate amount of foreign currency to SHEKELS at the rate fixed in advance. Another alternative is to use static (or better dynamic) hedge with options.

29 Risk Management Tools Jun-2000 slide 29 Example F Assume that for the following 7 years you have to pay each year $1M and you will get each year 5M NIS. F How one can hedge this cash flow? F What if amounts or timing is not precise?

30 Risk Management Tools Jun-2000 slide 30 How to hedge financial risk? F Static hedge Forwardsagreements that fix the price Futures Optionsstatic hedge F Dynamic delta or vega hedge, with a variable amount of options held. It is applicable if there is a very liquid market and low transaction costs.

31 Risk Management Tools Jun-2000 slide 31 pluto.mscc.huji.ac.il/~mswiener/ F Useful Internet sites F Regulators F Insurance Companies F Risk Management in SEC reports Risk Management resources

32 Risk Management Tools Jun-2000 slide 32 RMG F http://www.riskmetrics.com/ F http://www.pictureofrisk.com/ F http://www.riskmetrics.com/rm/splash.html F rmgaccess

33 Risk Management Tools Jun-2000 slide 33 Consulting F Oliver, Wyman and Co. F Willis Corroon F Richard Scora F Ernst and Young F Enterprise Advisors F Kamakura

34 Risk Management Tools Jun-2000 slide 34 Examples of Risk Reports http://www.pictureofrisk.com http://www.mbrm.com/ http://www.riskmetrics.com/rm/splash.html

35 Risk Management Tools Jun-2000 slide 35 Regulators F BIS F G-30 F FSA F SEC F market risk disclosure rules F market risk reporting F FED, FRB F our GARP report F Swiss Central Bank F Financial Accounting Standards Board

36 Risk Management Tools Jun-2000 slide 36 Who manages risk? Citibank Bank of England CIBC J. P. Morgan Bankers Trust AIG General Re Swiss Re Aetna Zurich Nike Sony Dell Computers Philip Morris Ford Motor

37 Risk Management Tools Jun-2000 slide 37 SEC reports F Edgar F Yahoo – find symbol – profile – raw SEC reports u market risk in 10K 7A

38 Risk Management Tools Jun-2000 slide 38 3 methods F Sensitivity – requires a deep understanding of positions F Tabular – when there are 1-2 major risk factors F Value-at-Risk – for active risk management

39 Risk Management Tools Jun-2000 slide 39 KPMG report Survey of disclosures: SEC Market Risk, 1999 SEC: http://www.sec.gov/smbus/forms/regsk.htm#quan http://www.sec.gov/rules/othern/derivfaq.htm GARP http://www.garp.com/

40 Risk Management Tools Jun-2000 slide 40 World Experience F Bankers Trust, J.P. Morgan, investment banks F Bank regulators, commercial banks F Insurance, dealers F Investment funds (LTCM) F Real companies F Investors learn to read risk information!

41 Risk Management Tools Jun-2000 slide 41 Agriculture www.cfonet.com/html/Articles/CFO/1999/99APkita.html 1998 revenues $1.25B consulting Willis Corroon

42 Risk Management Tools Jun-2000 slide 42 Nike F Salaries are paid in Asia F Shoes are sold worldwide F Financing comes from USA F Marketing, storing, shipping worldwide use VaR since 1998.

43 Risk Management Tools Jun-2000 slide 43 Merck http://www.palisade-europe.com/html/Articles/merck.html http://www.sec.gov/Archives/edgar/data/64978/000095012 3-99-005573-index.htmlsee sensitivity

44 Risk Management Tools Jun-2000 slide 44 Articles Value at Risk as a Diagnostic Tool for Corporates: The Airline Industry http://netec.mcc.ac.uk/WoPEc/data/Papers/dgruvati n19990023.html Agricultural Applications of Value-at-Risk Analysis: A Perspective http://netec.mcc.ac.uk/WoPEc/data/Papers/wpawu wpfi9805002.html

45 Risk Management Tools Jun-2000 slide 45 Publications The New Risk Management: the Good, the Bad, and the Ugly, P. Dybvig, W. Marshall http://dybfin.olin.wustl.edu/research/papers/riskma n_fed.pdf Association for Investment Management and Research http://www.aimr.org/

46 Risk Management Tools Jun-2000 slide 46 Web tour F ZW, students, VaR and risk management F Gloriamundy F GARP F SEC reports F Google

47 Risk Management Tools Jun-2000 slide 47 What is more risky and why? A. 1 year bond B. 10 year bond

48 Risk Management Tools Jun-2000 slide 48 What is more risky and why? A. An in-the-money option? B. An out-of-the-money option?

49 Risk Management Tools Jun-2000 slide 49 Call Value before Expiration Call XUnderlying In-the-money option Out-of-the-money option

50 Risk Management Tools Jun-2000 slide 50 What is more risky and why? A. A fixed interest loan? B. A floater (variable interest rate)?

51 Risk Management Tools Jun-2000 slide 51 The End

52 Risk Management Tools Jun-2000 slide 52 Tools F Measurement tools F Financial tools – options – forwards, futures – swaps – insurance F Outsourcing

53 Risk Management Tools Jun-2000 slide 53 Senior Management Marketing Finance Supply Cashflow Capital

54 Risk Management Tools Jun-2000 slide 54 Important Principles Distinction between risk taking and risk control. Backtesting. Transparent reporting. Timing is more important then precision!

55 Risk Management Tools Jun-2000 slide 55 Basic decisions F Goal of Risk Management F Base currency F Time horizon (embedded options) F Economic or Accounting approach F Admissible risk F Stop losses or other actions

56 Risk Management Tools Jun-2000 slide 56 Risk Management System F Predict future F Identify business opportunities F Be always right! Risk Management System Can F Predict loss, given event F Identify most dangerous scenarios F Recommend how to change risk profile Can NOT

57 Risk Management Tools Jun-2000 slide 57 Definition VaR is defined as the predicted worst-case loss at a specific confidence level (e.g. 99%) over a certain period of time.

58 Risk Management Tools Jun-2000 slide 58 Profit/Loss VaR 1% VaR 1%


Download ppt "Jun-00 Risk Management Zvi Wiener 02-588-3049 Tools for risk management."

Similar presentations


Ads by Google