An Introduction
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An Introduction
Risk, in traditional terms, is viewed as a ‘negative’. Webster’s dictionary, e.g. defines risk as “exposing to danger or hazard”. The Chinese give a much better description of risk
The first is the symbol for “danger”, while the second is the symbol for “opportunity”, Making risk a mix of danger and opportunity.
Mr. Ratan Tata in one of his speeches: "The ups and downs in life are equally important to keep us going, because a straight line, even in an E.C.G. means we are not alive."! RAJIV SRIVASTAVA
2
Risk can be defined as deviations of the actual results from expected. Risk can be classified two ways – 1) risk of small losses with frequent occurrences, and 2) risk of large losses with infrequent occurrences. The impact or magnitude of risk is normally estimated from following two factors The probability of an adverse event happening, and In case the event occurs the magnitude of the loss it can cause.
RAJIV SRIVASTAVA
3
. Project Risk
Financial Risk Price Currency Interest Rate Credit Portfolio
Operational Regulatory Political Liquidity Human Resource
Can be managed only by taking precautions on appraisal
RAJIV SRIVASTAVA
Mostly manageable by derivatives
4
. SYSTEMATIC RISK
UNSYSTEMATIC RISK
Risk specific to a group of assets, or the industry or the market as a whole
Risk specific to a particular asset.
Cannot be managed by diversification Managed by Derivatives
Managed by diversification to a large extent.
RAJIV SRIVASTAVA
5
. EVENT RISK
BUSINESS RISK
Risk of large losses with small probability such as earthquake, tsunami, riots, terrorism etc. May affect large number of firms/individuals
Risk of small losses with large probability such as price risk, exchange rate risk, interest rate risks specific to a particular firm. May affect large number of firms/individuals.
Can be managed by insurance if such policies are available.
RAJIV SRIVASTAVA
Can be managed by derivatives.
6
The ways to manage risk include attempt to control potential damage, diffuse, diversify and transfer risk to those willing to accept it. One can manage the risk by transferring it to another party who is willing to assume risk. Insurance company does not do anything to contain the risk per se but assumes risk on your behalf. Management of risk through derivatives is commonly referred as hedging which enables offsetting of risk emanating from a situation. RAJIV SRIVASTAVA
7
The 1. 2. 3.
business risks of price, exchange rate, and interest rate as also the credit risk
can be managed through derivatives. Management of risk through derivatives is tactical as distinct from strategic management. Strategic management is costly, mostly irreversible, time consuming and requires several opinions. RAJIV SRIVASTAVA
8
Derivatives
are products that derive their value from some other asset called underlying asset but in other aspects they may remain distinctly different from and independent of the underlying asset. Management of risk through derivatives in contrast to strategic management of risk is 1. 2. 3. 4.
quick, economical, reversible, and mostly provides protection in the short term. RAJIV SRIVASTAVA
9
If the prices of derivatives are linked to the physical market then why have derivatives as separate instrument?
Spot/Physical Market
Price from Spot Market
Derivatives Market
Enables take separate, independent and opposite positions in two different markets. If prices move in tandem opposite positions in two markets in makes hedging feasible. RAJIV SRIVASTAVA
10
Variety
of derivatives are available both as standard product and tailor-made, to suit various applications. Four broad and basic types of instruments are:
Forwards Futures Options, and Swaps,
Combinations
of derivatives are also available such as options on futures, swaptions etc for more complex applications. RAJIV SRIVASTAVA
11
Based on the underlying asset
The underlying asset can be Commodities Financial Currencies Shares/Indices Interest Rates Credit Others Weather Energy RAJIV SRIVASTAVA
Based on how traded
Derivatives can be traded either on the exchange or OTC Over-the-counter (OTC) Forwards, Options, Swaps Exchange Traded Futures, Options 12
Hedgers: are those who use derivatives for hedging i.e. reduce or eliminate risk. Speculators: are those take positions in derivatives to increase returns by assuming increased risk. They provide much needed liquidity to markets. Arbitrageurs: are those who exploit mispricing in two different markets; They assume riskless and profitable positions unlike speculators. All 3 participants are essential for efficient functioning.
RAJIV SRIVASTAVA
13
Enable price discovery because two independent markets are available for the same asset. It increases participation making markets deep. If derivatives are exchange traded then transparent prices are available worldwide.
Facilitate transfer of risk from those trying to avoid to those prepared to assume risk.
Provide leverage to attract speculators to participate and increase market depth enabling fair price.
RAJIV SRIVASTAVA
14
Increased volatility: Though used for efficient price discovery, derivatives when used as a speculative product can make increase volatility in prices. Increased bankruptcies: Derivatives being leveraged products have caused disproportionate positions leading to several disasters and bankruptcies. Increased burden of regulations: Most derivatives hide more than what they reveal, liabilities being contingent in nature. For financial discipline and better disclosures new rules have to be devised. Double-edged sword: If used judiciously it provides risk mitigation but if used injudiciously it magnifies risk.
RAJIV SRIVASTAVA
15
Rajiv Srivastava [email protected] [email protected] RAJIV SRIVASTAVA
16
6
5
4
3
2
1
0
Category 1
Category 2 Series 1
Category 3 Series 2
RAJIV SRIVASTAVA
Category 4
Series 3 17
Class
Group A
Group B
Class 1
82
85
Class 2
76
88
Class 3
84
90
RAJIV SRIVASTAVA
First
bullet point here Second bullet point here Third bullet point here
18
First
bullet point here Second bullet point here Third bullet point here
Group A • Task 1 • Task 2
Group B • Task 1 • Task 2
Group C • Task 1 • Task 2
RAJIV SRIVASTAVA
19
Risk, in traditional terms, is viewed as a ‘negative’. Webster’s dictionary, e.g. defines risk as “exposing to danger or hazard”. The Chinese give a much better description of risk
The first is the symbol for “danger”, while the second is the symbol for “opportunity”, Making risk a mix of danger and opportunity.
Mr. Ratan Tata in one of his speeches: "The ups and downs in life are equally important to keep us going, because a straight line, even in an E.C.G. means we are not alive."! RAJIV SRIVASTAVA
2
Risk can be defined as deviations of the actual results from expected. Risk can be classified two ways – 1) risk of small losses with frequent occurrences, and 2) risk of large losses with infrequent occurrences. The impact or magnitude of risk is normally estimated from following two factors The probability of an adverse event happening, and In case the event occurs the magnitude of the loss it can cause.
RAJIV SRIVASTAVA
3
. Project Risk
Financial Risk Price Currency Interest Rate Credit Portfolio
Operational Regulatory Political Liquidity Human Resource
Can be managed only by taking precautions on appraisal
RAJIV SRIVASTAVA
Mostly manageable by derivatives
4
. SYSTEMATIC RISK
UNSYSTEMATIC RISK
Risk specific to a group of assets, or the industry or the market as a whole
Risk specific to a particular asset.
Cannot be managed by diversification Managed by Derivatives
Managed by diversification to a large extent.
RAJIV SRIVASTAVA
5
. EVENT RISK
BUSINESS RISK
Risk of large losses with small probability such as earthquake, tsunami, riots, terrorism etc. May affect large number of firms/individuals
Risk of small losses with large probability such as price risk, exchange rate risk, interest rate risks specific to a particular firm. May affect large number of firms/individuals.
Can be managed by insurance if such policies are available.
RAJIV SRIVASTAVA
Can be managed by derivatives.
6
The ways to manage risk include attempt to control potential damage, diffuse, diversify and transfer risk to those willing to accept it. One can manage the risk by transferring it to another party who is willing to assume risk. Insurance company does not do anything to contain the risk per se but assumes risk on your behalf. Management of risk through derivatives is commonly referred as hedging which enables offsetting of risk emanating from a situation. RAJIV SRIVASTAVA
7
The 1. 2. 3.
business risks of price, exchange rate, and interest rate as also the credit risk
can be managed through derivatives. Management of risk through derivatives is tactical as distinct from strategic management. Strategic management is costly, mostly irreversible, time consuming and requires several opinions. RAJIV SRIVASTAVA
8
Derivatives
are products that derive their value from some other asset called underlying asset but in other aspects they may remain distinctly different from and independent of the underlying asset. Management of risk through derivatives in contrast to strategic management of risk is 1. 2. 3. 4.
quick, economical, reversible, and mostly provides protection in the short term. RAJIV SRIVASTAVA
9
If the prices of derivatives are linked to the physical market then why have derivatives as separate instrument?
Spot/Physical Market
Price from Spot Market
Derivatives Market
Enables take separate, independent and opposite positions in two different markets. If prices move in tandem opposite positions in two markets in makes hedging feasible. RAJIV SRIVASTAVA
10
Variety
of derivatives are available both as standard product and tailor-made, to suit various applications. Four broad and basic types of instruments are:
Forwards Futures Options, and Swaps,
Combinations
of derivatives are also available such as options on futures, swaptions etc for more complex applications. RAJIV SRIVASTAVA
11
Based on the underlying asset
The underlying asset can be Commodities Financial Currencies Shares/Indices Interest Rates Credit Others Weather Energy RAJIV SRIVASTAVA
Based on how traded
Derivatives can be traded either on the exchange or OTC Over-the-counter (OTC) Forwards, Options, Swaps Exchange Traded Futures, Options 12
Hedgers: are those who use derivatives for hedging i.e. reduce or eliminate risk. Speculators: are those take positions in derivatives to increase returns by assuming increased risk. They provide much needed liquidity to markets. Arbitrageurs: are those who exploit mispricing in two different markets; They assume riskless and profitable positions unlike speculators. All 3 participants are essential for efficient functioning.
RAJIV SRIVASTAVA
13
Enable price discovery because two independent markets are available for the same asset. It increases participation making markets deep. If derivatives are exchange traded then transparent prices are available worldwide.
Facilitate transfer of risk from those trying to avoid to those prepared to assume risk.
Provide leverage to attract speculators to participate and increase market depth enabling fair price.
RAJIV SRIVASTAVA
14
Increased volatility: Though used for efficient price discovery, derivatives when used as a speculative product can make increase volatility in prices. Increased bankruptcies: Derivatives being leveraged products have caused disproportionate positions leading to several disasters and bankruptcies. Increased burden of regulations: Most derivatives hide more than what they reveal, liabilities being contingent in nature. For financial discipline and better disclosures new rules have to be devised. Double-edged sword: If used judiciously it provides risk mitigation but if used injudiciously it magnifies risk.
RAJIV SRIVASTAVA
15
Rajiv Srivastava [email protected] [email protected] RAJIV SRIVASTAVA
16
6
5
4
3
2
1
0
Category 1
Category 2 Series 1
Category 3 Series 2
RAJIV SRIVASTAVA
Category 4
Series 3 17
Class
Group A
Group B
Class 1
82
85
Class 2
76
88
Class 3
84
90
RAJIV SRIVASTAVA
First
bullet point here Second bullet point here Third bullet point here
18
First
bullet point here Second bullet point here Third bullet point here
Group A • Task 1 • Task 2
Group B • Task 1 • Task 2
Group C • Task 1 • Task 2
RAJIV SRIVASTAVA
19
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