market risk & liquidity management and...market risk & liquidity management jawwad farid...

Market Risk & Liquidity Management

Jawwad Farid

alchemya.com

FinanceTrainingCourse.com

[email protected]

http://financetrainingcourse.com/educationhttp://www.alchemya.com/http://www.financetrainingcourse.com/mailto:[email protected]

Agenda

Introductions

Challenges

Market Risk

Questions

Wrap up

http://financetrainingcourse.com/education

3

Jawwad Intro

• Fellow Society of Actuaries, Investments

• MBA, Columbia Business School

• 21 years consulting: US, UK, MENA, Africa,

Pakistan & Far East.

• Risk Management, Product Development,

Regulatory Reporting, Actuarial Practice

• Prefers - Jawwad - (Pronounced Javaad)

http://FinanceTrainingCourse.com

http://www.alchemya.com

[email protected]

http://financetrainingcourse.com/educationhttp://financetrainingcourse.com/http://www.alchemya.com/mailto:[email protected]

Models at work

http://financetrainingcourse.com/educationhttp://www.amazon.com/Models-Work-Practitioners-Management-Financial/dp/1137371633/ref=sr_1_2?s=books&ie=UTF8&qid=1394961567&sr=1-2&keywords=models+at+work

Market Risk

Why is risk broken?


A survey of opinions

The governance structure is broken.

Market Risk and Middle Office function is dysfunctional.

The separation between Risk and business is not working.

The best risk managers come from business.


More opinions on risk

Risk is a dead end job. Can’t attract the right talent.

Is volatility the right measure?

Risk is the stupid trade that should have never happened.

Pre-Trade limit enforcement.


From hot to dead end.

1996-2000

2007 2014

Risk is hot. Risk models are hot.

Risk is broken. Risk is a dead end job.

Pricing models rule.


Top Questions

Why is risk broken?

What drives the distrust towards

risk in board rooms?

What can we do to fix it?

9


Non Integrative

Risk Management

Models vs. Applications

vs. Interpretation

Decoding Volatility

Reconciling Risk and Financial systems.

Why is risk broken?


• Unstable correlations

• Cyclical volatility

• Reconciling data with financial source systems.

• Credibility issues

• Reporting lines

• Backseat driving

• Talent management

• Gap between practice and theory

• Validation of models

Real World Models

Governance

Tracking Volatility

Single Source Data


Capital & Distribution

Distribution of Portfolio Value

50 70 90 110 130 150

Portfolio Value

Fre

qu

en

cy

Expected

Value

Critical

Barrier

Economic

Capital

Emergency

Management

Conditions

Normal

Operating

Conditions

Then

Now

12


Capital & Distribution

Distribution of Portfolio Value

50 70 90 110 130 150

Portfolio Value

Fre

qu

en

cy

Expected

Value

Critical

Barrier

Economic

Capital

Emergency

Management

Conditions

Normal

Operating

Conditions

Regulator,

Shareholders

Depositors,

Counterparties,

Rating Agencies

13


Real world models

Why is risk broken?


Thought experiment - One

Correlations


Distribution & Correlations

16


Correlations


The right blend - correlations


75

90

105

120

Crude Oil Blends - Prices

Brent Abu Dhabi- Murban Dubai- Fateh Iran-Heavy Saudi Arabia- Light


(1.00)

(0.60)

(0.20)

0.20

0.60

1.00

Correlation Abu Dhabi- Murban with Brent

Abu Dhabi- Murban with Brent


(1.00)

(0.60)

(0.20)

0.20

0.60

1.00

Correlation - Saudi Arabia- Light with Brent



Thought experiments- Two


24


Interest Rates - Volatility

0%

4%

8%

12%

15/03/2008 08/07/2008 31/10/2008 23/02/2009 18/06/2009

7 Days 14 Days 1 Month 3 Months

25


FX Rates - most

0.4%

1.2%

2.0%

2.8%

3.6%

13/03/08 09/06/08 05/09/08 02/12/08 28/02/09 27/05/09

AUD-JPY Sterling-JPY USD-AUD EUR-JPY

26


FX Rates - least

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

13/03/08 09/06/08 05/09/08 02/12/08 28/02/09 27/05/09

USD-JPY USD-EUR Sterling-EUR EUR-CHF

27


FX Rates Volatility – Emerging Markets

0.0%

0.8%

1.6%

2.4%

19/03/2003 29/03/2004 09/04/2005 20/04/2006 01/05/2007 11/05/2008 22/05/2009

Euro Sterling Japanese Yen US Dollar

Canadian Dollar Swiss Frank Australian Dollar

28


Tracking volatility

Trailing volatility & correlations


-

0.0

0.0

0.0

0.0

0.1

0.1

0.1

0.1

0.1

5-Jan-04 5-Jan-05 5-Jan-06 5-Jan-07 5-Jan-08 5-Jan-09 5-Jan-10 5-Jan-11 5-Jan-12

Trailing Vol - Trends

WTI_Volatility EUR_Volatility Gold_Volatility Silver_Volatility

30


Volatility - Distribution


Governance Structure


The Framework

Exposure Trend Marginal Impact

Capital

34


Connections

Price Risk Value

Products Limits

35


Price

36


Volatility

37


Models

38


Relative Value

39


Relative Value - II

40


Transaction & Exposure Limits

• Max Ticket size Within a Trade

• Max Product limit Within a security

• Max Daily limits Within an operating cycle

• Max Tenor Exposure Within a tenor or maturity

bucket

• Max Ticket Size Within a risk classification

or grade

41


Sensitivity Limits • Change in USD Equivalent Exposure

• Change in Position value per PiP To Exchange Rates

• Duration, PVBP, Gaps, Interest Rate Mismatch To Interest Rates

• Vega, Change in value, Change in projected P&L, Gamma To Volatility

• Change in projected earning, Net Interest Income or Earnings at Risk Earnings

• Change in Income, Market Value of Equity or NPV Shareholder Value

• Maximum Loss, Impact of ALM choices on Capital Equity or Capital

42


Limit Management

Limit Management

Counterparty Limits

Transaction Limits

Exposure Limits

Sensitivity limits

43


Governance

Business Risk Reporting

Lines

Conflicts Looking up, at or down?


Products & Payoffs

45


Limits

46


Reconciliation

Single Source of data


Volatility

Approaching volatility


Monthly Crude Oil Change

49


0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

120.00%

0

50

100

150

200

250

Crude oil price changes - daily

Frequency Cumulative %

50


Volatility - Distribution

51


Gold


Oil


Silver


EUR-USD



More Thought experiments



Model price vs. Market price vs. liquidity


Swap Points - A

58


Swap Points - B

59


Swap Points - C

60


Swap Points - D

61


Swap Points - E

62


Four relationships

Interest Rate Differential

Forward & Spot Differential

Expected Inflation Rate Differential

Expected change in spot rates

)1/()1( $rrlocal )1(/)1( $iEiE local

)/()( $/$/ locallocal Spotforward )/()( $/$/ locallocal SpotSpotE

63


Thought Experiement


Is Gold safe now?

65


Is Gold safe now?

66


Bubble and after

67


What is Risk?

A framework for risk management


Four Questions

Exposure Trend Marginal Impact

Capital / Appetite

69


Exposure

0

500

1,000

1,500

2,000

Lease Finance Long Term Short Term Finance Medium Term

70


Trend

0

50

100

150

200

250

300

1 2 3 4 5 6 7 8 9 10 11 12February March April May June

71


Exposure, Risk, Target Accounts

Exposures

• Gross Numbers

• Book Size

• Driven by Internal choices

Risk

• Probability that we may lose something

• Driven by external factors

Target Accounts

• Sit somewhere in the middle at the intersection of exposure and risk

72


What is exposure?

Exposure

Uncertain

Volatile

Financial Impact


What is a Target Account?

Measurable/

Reportable

Sensitive/ Relevant

Explainable/

Understandable


Exposure, Risk, Target Accounts

Exposures

• Gross Numbers

• Book Size

• Driven by Internal choices

Risk

• Probability that we may lose something

• Driven by external factors

Target Accounts

• Sit somewhere in the middle at the intersection of exposure and risk


Target Accounts & Impact

P&L

Risk & Capital

Benchmark

76


Governance revisited

Governance challenges


Who is the regulator?

• Central Bank, Securities regulator

• FMA & ACI Code of conduct Local

• OCC, Federal Reserve, FSA

• North American and EU regulations International

• Broadest definition.

• How do you teach morality to smart people? Morality


The Gambit – Rational thinking

Expected Payoff > Penalty Expected Payoff < Penalty


In an imperfect world?

• Impact

• Group behavior Social Costs

• Recognition

• The desire to get caught Personal Costs

• Direct

• In Direct

The cost of being caught

• Paradigm shift

• Make an example – The bite & teeth

Regulatory compensation


Cases & Messages

• The slide in security prices Misrepresentation

• FSA Libor Crisis, FX Exchange rate crisis

Collusion

• Front Running, Insider Trading, Gouging

Client Confidentiality


Consequence

• Fines, penalties

• Loss of license

• Civil Suit, Class Action Suit

Bank wide impact

• Suspension & Termination

• Negative lists

• Future prospects Management

• Suspension & Termination

• Negative lists Dealers


Q&A


Alchemy Intro

• Actuarial & Risk Advisory firm

• 11 years, 4 Markets

• Banking and Insurance Risk, Capital Adequacy Focus

• Derivative & Risk Management models, Treasury Management

• ALM, ICAAP, Stress Testing, Financial Product Development

• More than 3,000 trained participants across 150 workshops

84


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Jawwad Ahmed Farid

alchemya.com FinanceTrainingCourse.com

[email protected]
http://financetrainingcourse.com/educationhttp://www.alchemya.com/http://www.financetrainingcourse.com/mailto:[email protected]

market risk & liquidity management and...market risk & liquidity management jawwad farid...

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