FRMExport(2) - Introduction Chap 1 Financial Risk...

Info icon This preview shows pages 1–3. Sign up to view the full content.

Financial Risk Management Jos ´ e Da Fonseca email: [email protected] Auckland University of Technology Jul-2012 Introduction Chap 1 What is Financial Risk Management and why is it important? Which risks can we manage? How can we measure risk? The Concept of Risk Risk is the uncertainty of events happening in the future Although the concept of risk is intuitive, quantifying risk is less obvious Quantification of risk was initiated by Pascal and Fermat (1654) who assessed the outcomes of games of chance with probabilities Since then, risk has been associated with probabilities/statistics Only in 1952 a statistical measure was introduced to measure the risk of a stock Focus of this Paper This paper addresses various tools to manage financial risk Derivative Prod- ucts A derivative is an instrument whose value depends on the values of other more basic underlying variables Derivatives are broadly classified as linear products (Futures, Forwards, Swaps) and non-linear products (Options) RM use of Derivatives Derivatives are often added to outstanding positions to reduce the overall expo- sure of the portfolio Since derivatives move in the same direction as the underlying, we should take the opposite position in the derivative to hedge our current position Derivatives are further used: To speculate in Financial Markets To profit from Arbitrage Opportunities To change the nature of your investment or liability Futures/Forwards I A futures/forwards contract provides the obligation to trade a certain asset/commodity in the future. Note that you do not buy a futures or forward, but you take a position Long position: The person receiving the asset/commodity Short position: the person delivering the asset/commodity You do not pay for a Future or a Forward as both parties have the same obligation: It’s an agreement
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

Futures /Forwards II Futures are exchange traded contracts and were traded first at the Chicago Board of Trade (CBOT) and the Chicago Mercantile Exchange (CME). Forwards are traded over the counter (OTC). The value of futures and forwards is linear wrt the underlying a45 a54 a27 a63 P V a0 a0 a0 a0 a0 a0 a0 a0 Swaps Swaps are OTC traded products Two parties agree on swapping their exposures (e.g. obligations) F OR EXAMPLE : A US firm has obligations in the UK, whereas a UK firm has obligations in the US. They swap their obligations (for the same amount), such that the US firm will meet the obligations in the US and the UK firm will meet the obligations in the UK Options I The buyer of an option has the option to buy/sell the asset at the end of the contract, i.e. a right to buy/sell The seller of the contract (writer) has the obligation to meet the buyer.
Image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern