chance/brooksan introduction to derivatives and risk management, 7th ed.ch. 16: 1 chapter 16:...

Chance/BrooksAn Introduction to Derivatives and Risk Management, 7th ed. Ch. 16: 1

Chapter 16: Managing Risk in an Organization

I think ‘risk manager’ is a misnomer. I don’t manage I think ‘risk manager’ is a misnomer. I don’t manage the risks-it’s up to the businesses to manage the risks. the risks-it’s up to the businesses to manage the risks. What we’re here to do is to provide assurance that What we’re here to do is to provide assurance that risks are being monitored and managed.risks are being monitored and managed.

Kate BoothroydKate Boothroyd

Treasury and Risk Management, November 2004, p. Treasury and Risk Management, November 2004, p. 5555


Important Concepts in Chapter 16

The differences between the practice of risk The differences between the practice of risk management by end users and by dealersmanagement by end users and by dealers

Principles of effective risk management in an Principles of effective risk management in an organizationorganization

Accounting for derivativesAccounting for derivatives How some organizations lost money using How some organizations lost money using

derivativesderivatives Responsibilities of senior managementResponsibilities of senior management


The Structure of the Risk Management Industry

End UsersEnd Users Firms that engage in derivatives transactions Firms that engage in derivatives transactions

to manage their risk.to manage their risk. Mostly non-financial corporations, but also Mostly non-financial corporations, but also

pension funds, mutual funds, U.S. state and pension funds, mutual funds, U.S. state and local governments, foreign governments, local governments, foreign governments, endowments, and other private endowments, and other private organizations.organizations.

In corporations the treasury department is In corporations the treasury department is usually responsible for derivatives usually responsible for derivatives transactions.transactions.


The Structure of the Risk Management Industry (continued)

DealersDealers Financial institutions that make a market in Financial institutions that make a market in

derivatives. They stand willing to take derivatives. They stand willing to take either side (be a buyer or seller)of a either side (be a buyer or seller)of a derivatives transaction.derivatives transaction.

They typically hedge their risk and earn a They typically hedge their risk and earn a profit off of the difference between their profit off of the difference between their buying and selling prices.buying and selling prices.


The Structure of the Risk Management Industry (continued)

Other Participants in the Risk Other Participants in the Risk Management IndustryManagement Industry consultants, including accounting, consultants, including accounting,

management consulting, and management consulting, and personnel searchpersonnel search

software firmssoftware firms law firmslaw firms

Chance/Brooks An Introduction to Derivatives and Risk Management, 7th ed. Ch. 16: 6

Organizing the Risk Management Function in a Company

Good risk management requires a sound Good risk management requires a sound organization structure that begins with organization structure that begins with responsibility at the top.responsibility at the top.

Dealers usually have an independent risk manager Dealers usually have an independent risk manager who reports to the CEO, has access to relevant who reports to the CEO, has access to relevant information, and authority to block or initiate information, and authority to block or initiate certain transactions.certain transactions.

Corporate risk management should also be Corporate risk management should also be centralized but is often decentralized.centralized but is often decentralized.

Many corporations run the treasury as a profit Many corporations run the treasury as a profit center, which is not conducive to sound risk center, which is not conducive to sound risk management.management.


Organizing the Risk Management Function in a Company (continued) Separation of front office from back office.Separation of front office from back office. Legal counsel, accounting, and auditing are critical, Legal counsel, accounting, and auditing are critical,

but accounting and auditing do not substitute for but accounting and auditing do not substitute for risk management.risk management.

Risk management is a continuous process requiring Risk management is a continuous process requiring regular evaluation and comparison to objectives.regular evaluation and comparison to objectives.

See See Figures 16.1, p. 568 and , p. 568 and 16.2, p. 569 for for examples of typical dealer and corporate end user examples of typical dealer and corporate end user organization charts.organization charts.

Under enterprise risk management, the Under enterprise risk management, the management of all risks is under a single area of management of all risks is under a single area of responsibility.responsibility.


Avoiding Derivatives Losses

See See Table 16.1 partial list of organizations partial list of organizations reporting derivatives losses.reporting derivatives losses.

Four case studies:Four case studies: Metallgesellschaft: To Hedge or Not to Metallgesellschaft: To Hedge or Not to

Hedge?Hedge? Orange County, California: Playing the Orange County, California: Playing the

OddsOdds Barings PLC: How One Man Blew up a Barings PLC: How One Man Blew up a

BankBank Proctor & Gamble: Going Up in SudsProctor & Gamble: Going Up in Suds


Risk Management Industry Standards Two organizations have established Two organizations have established

standards for the practice of risk standards for the practice of risk management:management: Group of 30 (G-30). See Group of 30 (G-30). See Table 16.2 Risk Standards Working Group. See Risk Standards Working Group. See

Table 16.3

Chance/BrooksAn Introduction to Derivatives and Risk Management, 7th ed.Ch. 16: 10

Responsibilities of Senior Management Senior management is ultimately responsible Senior management is ultimately responsible

for all organizational activities. With respect for all organizational activities. With respect to risk management, these responsibilities can to risk management, these responsibilities can be summarized as:be summarized as: Establish written policiesEstablish written policies Define roles and responsibilitiesDefine roles and responsibilities Identify acceptable strategiesIdentify acceptable strategies Ensure that personnel are qualifiedEnsure that personnel are qualified Ensure that control systems are in placeEnsure that control systems are in place

Chance/BrooksAn Introduction to Derivatives and Risk Management, 7th ed.Ch. 16: 11

Summary

chance/brooksan introduction to derivatives and risk management, 7th ed.ch. 16: 1 chapter 16:...

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n risk management

n corporate risk management

risk management function

sound risk management

practice of risk management

company n good risk

management consulting

independent risk manager