need for capital by reducing the collateral adjusted exposure to counterparty

Need for capital by reducing the collateral adjusted

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need for capital by reducing the collateral adjusted exposure to counterparty credit risk(Dodd, 2007). iv) Customer protection regulation: Customer protection concern is usually addressed by regulatory standards imposed on financial intermediaries relating to the integrity, skill and diligence, conflicts of interest, conduct of business, including order execution, restrictions on misuse of information, prohibition on misrepresentation, disclosure standards and the availability of procedures to resolve customer grievances (Saksena, 2003). 2.4.3 Risk Management and financial derivatives market Risk management is the process of identifying, quantifying, and managing the risks that an organization faces, D. w cox (2007). As the outcomes of business activities are uncertain, they are said to have some element of risk. These risks include strategic failures, operational failures, financial failures, market disruptions, environmental disasters, and regulatory violations. People and institutions are confronted with risk in some form, whenever they make transactions in financial markets. Several financial markets and institutions provide opportunities to transfer risk, Bernanke, B.S, (2008). Due to financial innovation, these 22
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opportunities have been improved tremendously in the last five decades. Insurance companies owe their existence to the presence of risk-aversion. Shiller (1993) argued that new financial products should be introduced to track the health of regional industries, housing prices, and other shocks that affect many individuals’ livelihoods. The key thing to note about this hedging is that the conditions under which it provides a satisfying explanation for financial activity are simple and clear. Individuals on the two sides of a trade should be differentially exposed to some source of risk and the trade they undertake should mitigate this. Banks also partly owe their existence to the presence of risk-aversion. Depositors are willing to accept an interest rate, which is considerably lower than the interest rate paid by borrowers to the bank. They do it because the bank carries the default risk on the borrowers. Credit default swaps and other derivatives are designed to transfer risk between seller and buyer. Risk does not disappear, when it is traded. It is moved from one market participant to another at a price. Such risk transfers increase the welfare of the society as risk- averse market participants improve their own utility by paying risk-willing counterparties to carry the risk, John C Hull (2007). Risk-takers play an important role in financial markets. Banks carrying the default risk on their borrowers have a strong incentive to monitor the performance of them. Credit evaluation by bankers is in dispensable, Merton (1995). Value at Risk-VaR, results depend upon volatility inputs, since volatility is used to create the dispersion of portfolio values, and as volatility used by the VaR models increases, initial margin will increase, Lopez, J., (1999).
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