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Market Risk - Measurement, Mitigation and Regulatory Treatment

Duration: 3 days
  • Best Practices in Market Risk Management
  • Quantitative Tools for Market Risk Measurement
  • Measuring and Managing Equity Risk
  • Measuring and Managing Interest Rate Risk
  • Quantifying FX and Commodity Risk
  • Value-at-Risk and Stress Testing
  • Regulatory Treatment of Market Risk
The objective of this course is to give you a good and practical, “hands-on” understanding of strategies, tools and techniques for managing market risks.

We start with a general introduction to market risk and discuss how recent years’ dramatic developments in financial markets have lead to an increased urgency in managing risk generally. We review current best practices in market risk management, and we explain the process of identifying, measuring and managing market risk. We also introduce and explain the “general” quantitative techniques that are used in risk quantification.

We then turn to look in more detail at how the individual types of market risk are measured and managed. We explain and demonstrate how equity risk is measured at the single instrument and portfolio levels and how these risks can be mitigated using futures, options and swaps. Further, we explain how interest rate risk is measured using the duration concept, and we explain and demonstrate how general interest rate risk, yield curve risk and spread risk can be hedged using interest rate derivatives. We also explain and demonstrate how FX and commodity risk can be measured and managed.

After looking at the individual risk types, we introduce the important, aggregate risk measure “Value-at-Risk” (VaR). We explain how VaR is calculated for various risk types. We discuss the strengths and weaknesses of VaR and we point out the pitfalls of using VaR in isolation. We also explain how “stress testing” can and should be used to complement VaR measures.

Finally, we give you a thorough review of the regulatory treatment of market risk under the Basel rules. We explain and demonstrate how the “pillar 1” capital charges are calculated. We also explain how market risks are treated under “pillar 2”, and we discuss the internal and external reporting requirements.

Day One

09.00 - 09.15  Welcome and Introduction

09.15 - 12.00  Introduction to Market Risk Management

  • Why Market Risk Has Become More Important – Again
    • Globalization and integration of markets
    • Increased volatility
    • Tougher regulation/Increased capital charges
  • Overview of Types of Market Risks
  • Best Practices in Market Risk Management
  • The Risk Management Triangle: Identification, Measurement and Management
  • Market Risk Management Functions in a Bank
    • Control, Supervision and Limit Setting
    • Valuation (Mark to market) and P/L Monitoring
    • Risk Measurement and Board Reporting
  • Basel Capital Requirements for Market Risk – Overview

Quantitative Tools for Market Risk Measurement

  • The Components of Market Risk
  • Measuring Return and Volatility
  • Probability, Loss Distributions, Arbitrage Models
  • Exercises

12.00 - 13.00  Lunch

13.00 - 16.30  Measuring and Managing Equity Risk

  • Drivers of Equity Risk
  • Macroeconomic Factor Models
  • Systematic and Unsystematic risk
  • Measuring Systematic Risk (Beta)
  • Risk Pricing
    • The Capital Asset Pricing Model (CAPM)
    • The international CAPM
    • The equity premium puzzle
  • Managing Equity Risk with Derivates
    • Equity derivatives – market overview
    • Altering portfolio beta with index futures
    • Hedging equity portfolios with equity options
    • Hedging with equity swaps
  • Case Studies
  • Exercises

Day Two

09.00 - 09.15  Recap

09.15 - 12.00  Measuring and Managing Interest Rate Risk

  • Price and Yield Analysis
  • Duration Analysis, BPV and Convexity
  • Interest Rate Volatility
    • Price and Yield Volatility
  • Leverage and Interest Rate Risk
  • Measuring Yield Curve Risk
    • “Bucketing”
    • Key rate duration
    • Principal components analysis
  • Pre-payment and Option Embedded Risks
  • Measuring Interest Rate Risk at the Portfolio Level
  • Managing Interest Rate Risk with Derivatives
    • Interest rate derivatives – market overview
    • Altering portfolio duration with bond futures
    • Hedging interest rate risk with swaps
  • Case Studies and Exercises

12.00 - 13.00  Lunch

13.00 - 16.30  Measuring and Managing FX Risk

  • Key Determinants of FX Volatility
  • Measuring FX Exposure
    • Economic exposure, translation exposure and transaction exposure
  • FX Volatility and Single-Position Risk
  • FX Portfolio Risk
  • Managing FX Risk with Forwards, Swaps and Options
    • Hedging principal value vs. total economic Risk
  • Case Study and Exercise

Measuring and Managing Commodity Risk

  • Types of Commodities and their Risks
  • Volatility and Correlation of Commodity Returns
  • Hedging Commodity Risk with Commodity Derivatives
  • Case Study and Exercise

Day Three

09.00 - 09.15  Recap

09.15 - 12.00  Portfolio Market Risk

  • Portfolio Effects and Diversification
  • Correlation and Covariance Analysis
  • Composite and Portfolio Risk Measures

Value at Risk and Stress Testing

  • What is “Value-at-Risk”?
  • Uses of VaR in Risk Management
  • Ways of Measuring VaR
    • Parametric and non-parametric VaR
    • Historical simulation
    • Monte Carlo simulation
  • Calculating VaR for Linear Exposures
  • Calculating VaR for Non-linear Instruments
  • Stress Testing
    • Why stress testing?
    • Main uses of stress testing
    • Scenario analysis
    • Mechanical approaches
  • Case Study and Exercise

12.00 - 13.00  Lunch

13.00 - 16.30  Regulatory Treatment of Market Risk

  • The Risk Measurement Framework
  • The Standardized Measurement Method
    • Interest rate risk
    • Equity position risk
    • Foreign exchange risk
    • Commodities risk
    • Treatment of options
  • The Internal Models Approach
    • Qualitative and quantitative standards
    • Specification of market risk factors
    • Stress testing
    • External validation
  • Revised Rules for Treatment of Counterparty Risk (Basel III)
  • Regulatory Reporting (Pillar II + III)
  • Internal Reporting and Control (limits etc.)

Summary, Evaluation and Termination of the Seminar