Tuesday, April 18, 2017

ERM

ERM: Enterprise Risk management
Centralized risk management
To:
Meet business obj, minimize unexpected earning volatility and maximize firm value

CRO may report to board or CEO/cfo, BUT A DOTTED relation should be between CEO/CRO to avoid conflicts.

Risk management should be transparent to outside

Monday, April 17, 2017

Corporate Governance And Risk Management

    Best  practices:

    • Independent board member
    • Take care of stakeholder and debt holder
    • CEO not the head and introduce CRO
    • Agency risk
    • Focus on economic performance instead of accounting performance
    • Compensation based on risk adjusted return
Board of directors oversee:
  • Policies, reports, strategy, control , audit, practics
Risk appetite -> tolerance/willingness a firm can take risk.

Transmitted by risk director and audit committee

Audit main role: make sure financial statement and regulatory report correct. Also oversee risk and so on

Hedging Risk Exposure


Hedging Risk Exposure:


Disadvantage: 

In theory:

  1. assume no tax and has same transaction cost, then the value dos not change…..Too fake
  2.  CPAM suggests focusing on  systematic risk (common for player) while non-systematic ones can be diversified (no perfect market)
  3. Derivative fully reflect underlying. Of course no, partial correlation, even no related derivative available

They do not consider bankruptcy.

In practice:

  1.  lose focus on making money
  2. Lack of knowledge
  3. Reduce volatility of value may result in reduce of earning cash flow

Advantage:


  1. Stable earning make fund raising easy
  2. Achieve board of director's goal
  3. Stable operation cost (put on consuming materials)
  4. Chance to get low tax


Hedging  Decision

 

Hedging  Decisions


The role of board of director
Decide firm's risk appetite with
  1. Decision on appetite  (accounting or economic, eg. Fx, short or long term heding eg. Put maturity, hard limit on quantities )
  2. With Quantative
  3. And qualitive method

Map risks

Analyze top 10 risk exposures according to market risk, credit risk, operation, business and so on. Give it dollar value. Ready for next step, hedge

Hedging risks


Pricing risk: fwd or call

FX: FX fwd, swap

Interest rate:  irs

Static vs Dynamic
Static, once decided, does not change
Dynamic, changing  but more transaction cost

Others:

  1. Time horizon goad matches
  2. If hedging position matches the goad
  3. Tax

Hedging instrument

OTC: difficult to price, less info, credit risk and so on…but I think it is cheaper most of time and designed for purchaser.
Exchange Traded : standard, clear price, enough info 

Sunday, April 16, 2017

Risk Management: A Helicopter View

  1.     Concept of Risk
    Risk  -> volatility of uncertain risk and uncertain gains -> risk take, profit gain. 
            -> 1. expected, can be well expected 2. unexpected (focus)
    Risk Management :
    A) manage expected risk
    B) manage unexpected risk

    Ultimately, determine the risk taking (take risk to gain)

     2.   Risk Management steps:

    Identify-> evaluate exposure->propose method->develop strat -> reevaluate/readjust
    Not perfect:
    A)  fail to identify risk B) no proper method
    1. Quantative measure:
    VaR95 -> %95 confidence level of min loss or 95% significance level of max loss
    Economic reserve:  ER =  ED*EP*ER , expected default rate* exposure*expected loss rate
    To keep liquidity and avoid from bankruptcy

    1. Qualitative measure:
    Scenario analysis: eg. Worst case scenario analysis looking at macroeconomic scenarios on entity
    Stress testing: stress on entity (shock factors etc)

     5.   ERM

    Look at risk overall firm, apply quant and quality analysis, board of director decide risk appetite, review, audit and so on

    1. Expected Loss vs Unexpected Loss
    EL: normal course, single factor with statistics collected from history and can be mitigated with increasing charge, spread over
    UL: unormal course, multi correlated factors, can be studied with hist data to gain some certainty

    1. Risk And Reward
    The more risk taken the more reward have, but reward has volatility.

     8.  Risks

      Market Risk:  market price/rate changes

      Interest rate risk, bond, unhedged, basis risk ( hedge not favorable)
      Equity Price risk , all market, secpecific ( diversify)
      FX Risk,  international interest rate
      commodity risk, sudden jump, black box
     

    Credit Risk:  counterparty cannot settle

     Default risk: fail to pay, bond
    Bankruptcy risk
     Downgrade risk downgraded ->default
    Settlement Risk:  in derivative (eg swap) losing party fail to pay

    To mitigate:
    Rate consider the risk taken, avoid concentration, avoid maturity concentration.

    Liquidity risk

    Funding risk: no money to pay, repurchase and etc
    Liquidity risk: cannot buy/sell with lack of counterparty

    Operation risk:
    Internal process and unexpected and unavoidable external factors.

    Legal and Regulatory Risk

    Tax, orders laws and etc

    Business Risk

    Things with specific product ( eg, production-consumption relation

     

    Strategic Risk

    Stupid board/management made stupid decision

    Reputation Risk


    Eg. Sanlu milk powder