FRM Notes 2011 Unit IC The Risk Management Environment

FRM Notes 2011 Unit IC The Risk Management Environment -...

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Version: January 3, 2011 FIN 7400: Financial Risk Management Unit IC Notes Page 1 of 8 D. M. Chance, LSU I. CONCEPTS OF RISK MANAGEMEN T C. The Risk Management Environment Risk management products are of two types: exchange-listed and over-the-counter. Exchange-listed products: futures, options Over-the-counter products: forwards, swaps, options The Exchange-Listed Derivative Markets Exchange-listed products trade on a derivatives exchange, which can involve going onto a physical location and transacting face to face with a counterparty (however, a broker can be used to represent a party). Alternatively, many derivatives exchanges have electronic trading, which involves trading with terminals or on the Internet. Exchange-listed products are standardized, guaranteed against default, and typically require the use of a broker. The industry for exchange- listed products is highly regulated at the federal government level. Exchange-listed products have a guaranteed market, meaning that the market makers commissioned by the exchange will always be willing to trade. Nonetheless, the market can still be quite thin. Major Derivatives Exchanges (listed by volume in 2009) Korea Exchange EUREX [Frankfurt] Chicago Mercantile Exchange Group (CME) (Chicago Mercantile Exchange and the Chicago Board of Trade) NYSE Euronext Chicago Board Options Exchange (CBOE) BM&Fbovespa (Brazilian Mercantile & Futures Exchange) National Stock Exchange of India Nasdaq OMX Russian Trading Systems Stock Exchange Shangahi Futures Exchange The entire list of global exchanges ranked by volume is at http://www.futuresindustry.org/volume-.asp Over-the-Counter Derivatives Markets Over-the-counter transactions are trades that are negotiated directly between two parties outside the confines of a financial exchange. All aspects of the trade are customized by the two parties. Any two parties anywhere can engage in such a transaction. OTC transactions are essentially unregulated, though the parties themselves might be regulated by banking or securities
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Version: January 3, 2011 FIN 7400: Financial Risk Management Unit IC Notes Page 2 of 8 D. M. Chance, LSU authorities. Of course, the transactions cannot violate any laws, but unlike exchange-listed derivatives, there are no significant restrictions on what types of transactions can be done. OTC transactions are also subject to credit risk, though there are methods for reducing credit risk, which are widely used in the industry (credit risk is covered later in this course). OTC markets are typically considered somewhat illiquid, but competition keeps certain OTC markets extremely active and, therefore, highly liquid. The participants of the risk management industry consist of several primary groups: Dealers, insurance companies, end users, software firms, consulting firms, law firms, and regulators Institutions that Operation in the Risk Management Environment Dealers In the over-the-counter derivatives market, the heart is the group of banks and securities firms
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FRM Notes 2011 Unit IC The Risk Management Environment -...

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