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Managing Derivatives Risk

Duration: 2 days
  • Risks in Derivatives Transactions
  • Overview of Derivatives and their Key Risks
  • Managing Market Risk in Derivatives Transactions
  • Controlling Credit & Counterparty Risk in Derivatives
  • Handling Liquidity Risk in Derivatives
  • Reducing Operational Risks in Derivatives
  • Mitigating Legal and Reputational Risk in Derivatives
The objective of this course is to give you a good and practical understanding of the risks encountered in derivatives transactions and of the methods and tools for managing these risks both on an individual and on an aggregate level.

We start by identifying and defining the major risk groups within derivatives and discuss how they inter-relate.

Subsequently we review and analyze the risk structure of key derivatives covering both exchange traded and OTC derivatives and we analyze how the risks differ from instrument to instrument.

We then look at how market risk in derivatives can be measured and managed. We identify and analyze the different types of market risk. We show how the market risk can be measured individually and on a portfolio level using Value-at-Risk and we discuss the mapping of a large portfolio to key risk factors.

On day two, we look at how credit & counterparty risk can be measured using a simple add-on method and a more comprehensive “potential future exposure” method. We explain how counterparty risk can be effectively managed using active counterparty credit monitoring, counterparty position limits, margining and collateral.

We continue by looking at liquidity risks of derivatives where key measures include open interest, volume and swap spreads. We discuss transactional liquidity risks of derivatives as well as liquidity shocks and so-called liquidity “Black Holes”.

Finally we look at other risks involved in derivatives transactions with special emphasis on operational risk and legal & reputational risk.

Within operational risk we focus at the key challenge with derivative risk models and the robustness of mitigating techniques. We also present a number of sound practices for managing operational risk.

Within legal & reputational risk we look at why the legal risks of derivatives are unique from traditional banking products. We introduce a concept how to associate costs with legal risks and show how legal & reputational risk can be modelled and used for limit setting. Finally we discuss how to mitigate legal & reputational risk by fostering a “know your client” culture within the bank.

Day One

09.00 - 09.15 Welcome and Introduction

09.15 - 12.00 Risks in Derivatives Transactions

  • The Concept of Risk and Derivative Instruments
    • Building Blocks of Derivative Products
    • Key Features of Derivative Transactions
    • Underlying Asset Specific Issues
  • Identifying and defining major Risk Groups
  • Pitfalls in the Risk Management of Derivatives
    • Famous Failures
    • Lessons to be learned from these failures
  • Regulatory Aspects

Overview of Derivatives and their Key Risks

  • Forward Contracts
  • Futures Contracts
    • Assessing eventual Delivery Options (CTD etc.)
  • Swaps and Swap related Contracts
  • Options
  • Exotics
  • Structured Products
  • Credit Derivatives
  • Securities Lending
  • Integrating and Aggregating different Derivatives into Portfolios
    • Problems and possible Solutions

12.00 - 13.00 Lunch

13.00 - 16.30 Measuring and Managing Market Risk in Derivatives

  • Types of Market Risk in Derivatives
    • Directional and Spread
    • Volatility and Correlation
  • The Components of Market Risk
    • Risk Factors
    • Risk Position
    • Risk Sensitivity
  • Measuring Equity Risks of Derivatives
  • Measuring Interest Rate Risk of Derivatives
  • Measuring FX Risks of Derivatives
  • Mapping of Market Risk in Derivatives to Key Risk Factors
  • Measuring Market Value-at-Risk
  • Managing Market Risks using a Risk Warehouse Principle

Day Two

09.00 - 09.15 Recap

09.15 - 12.00 Measuring and Managing Credit & Counterparty Risk in Derivatives

  • Main Types of Credit & Counterparty Risk in derivatives
    • Pre-settlement and Settlement Risk
    • Payment Timing Mismatch Risk and Premium Payment Risk
    • Lending Risk, Issuer Risk and Transfer Risk
  • Exposures Definitions
    • Calculating Current Exposure + add-on
    • Modelling Potential Future Exposure
  • Credit & Counterparty Risk Mitigation Techniques
    • Counterparty Credit Monitoring and Credit Line Limits
    • Early Termination of Deals and Netting
    • Collateral, Resets and Thresholds
  • Key documents
    • Master Agreement + Credit Support Annex

Measuring and Managing Liquidity Risk in Derivatives

  • Measuring Liquidity of Derivative Markets
    • Open Interest and Volume
    • Liquidity and Swap Spreads
  • Transactional Liquidity Risk in Derivatives
    • Secondary Market, Initial and Variation Margin
  • Liquidity Shocks and Liquidity “Black Holes”
    • The Flash Crisis in May 2010
  • Sound Practices for Liquidity Risk Management

12.00 - 13.00 Lunch

13.00 - 16.30 Measuring and Managing other Risks in Derivatives

  • The G-30 Report on Financial Derivatives
  • Operational Risk
    • Key Challenges with Derivative Risk Models and Software
    • Robustness of Mitigating Techniques
    • Sound Practices for Managing Operational Risk
  • Legal and Reputational Risk
    • Types of Legal and Reputational Risks
    • Why are the legal risks of derivatives unique from traditional banking products?
    • What are the Costs of Legal Risk?
    • Modelling Legal Risk and Reputational Risk
    • Defining and working with Legal Risk Limits
    • Fostering a “Know your Customer “ Culture

Evaluation and Termination of the Seminar