FINANCIAL RISK MANAGEMENT Table of Contents Risk Management and Bear Stearns 3 Introduction 3 Risk Management: An Overview 3 Risk management policies followed by Bear Stearns 4 6 Risk Management and Bear Stearns Introduction The Bear Stearns Companies, LLC, founded in 1923, was a New York based company which was involved in investment banking, trading of securities and derivatives and brokerage activities globally all over the world…
This study involves a comprehensive study of the risk management policies followed by Bear Stearns and how it led to its demise. Risk Management: An Overview Risk is a term associated with any type of business entity. Without risk it would have been an easy task for managers of a company to allocate its resources in the most effective way. And with the world experiencing the global financial crisis in the year 2008, effective and efficient risk management is the key to success for any financial enterprise. The idea of risk management may differ from person to person. In case of regulators risk management is a means of control, for traders it is a means of hedging their risks and for risk managers it is a means of obtaining the highest return possible by allocating capital in the best possible way. Risk management takes into consideration the magnitude as well as the nature of risks involved. It is all about optimizing the risk-return profile of a company. Sources of risk are many and it is due to the uncertainties of future events. In today’s world banks are engaged in wide range of activities like trading of derivatives to its customers which results in exposure, finally leading to risks. Thus risk management plays a vital role in case of banks. Study and analysis of risk begins with study of Markowitz model of portfolio analysis where he defined selection of portfolios based on mean of variances in return of portfolios. Sharpe and Lintner further added to this analysis by assuming the existence of risk free assets. The rate of return of a risky asset is governed by its systematic risk and ‘beta’ is the measure of this type of risks. Next Black-Scholes model for pricing of options gives a measure of the risk of an underlying security by measuring the volatility in the form of standard deviation. Again works of Modigliani and Miller showed that value of the firm is not dependent on the capital structure of the firm. Increase of debt, leading to greater leverage in the capital structure of a firm increases the financial risk for the shareholders of the firm. This means, reengineering of capital structure of the firm would not help the firm, and the management should consider implementing strategies to increase the value of the firm economically. However, it is very difficult and possesses a challenging task for a company to implement these risk management theories practically. For any financial institutions like global banks, before taking up risk management system they must ensure that, they are up to date with their databases regarding various financial transactions within the company and are also aware about financial rates available in the outside market. Also they must have relevant statistical tools to analyze those data. Risk management policies followed by Bear Stearns Bear Stearns was once considered as one of the most efficient managers of risk but at the end it was their faulty risk management policies that led to their downfall. Bear Stearns most profitable division was the securitization of mortgage, which brought in almost half of the company’s revenues. Regarding mortgage securitization, the company followed a model that was vertically integrated and made profit at every step starting from originating loan, securitizing them and then selling them. These ...
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(Financial Risk Management Essay Example | Topics and Well Written Essays - 1000 Words)
“Financial Risk Management Essay Example | Topics and Well Written Essays - 1000 Words”, n.d. https://studentshare.net/finance-accounting/58785-financial-risk-management.
Financial Risk Management
Many financial and non-financial organizations currently report the significance of value-at-risk (VaR), a risk that calculates for possible losses. Domestic uses of VaR and other complicated risk measures are on the increase in many financial institutions, where, for instance, a banks risk group can set VaR limits, both probabilities and amounts, for fund management and trading operations.
This report is aimed at demonstrating how futures contracts can be used as a hedging strategy that would also isolate profitable opportunity for the firm. This been achieved by taking a long position on futures contracts, and the hedging strategy turn out to be profitable for the firm.
Among such products financial derivatives are products that are extensively used (Bodnar, Graham, Harvey, & Marston, 2011). Derivatives, as the name implies, are financial products the value of which is derived from the other financial security. In addition to security based valuation, derivatives can also be developed based on the values derived from the any particular rate as well as index such as Interest Rate Swap etc (Cowell, 2006).
The investors need to have diversified portfolio for reducing the performance risk. In a similar manner, it is essential for the financial institutions to implement effective risk management procedures and techniques for mitigating the financial risks. It is very important to reduce the credit risks and interest rate risks which can have negative impact on the performance of the financial institutions.
The author states that exchange rate appears in the financial section of newspaper each day. The number of US dollar required purchasing one unit of foreign currency, this is call direct quotation. Direct quotation has a dollar sign in their quotation. The number of foreign currency that can be purchase for one dollar are called indirect quotation.
A very good example is of Honeywell Inc. Honeywell has used an overall annual aggregate retention to manage its risks rather than using separate retentions for each risk. This does not only reduce premiums paid to
The paper highlights certain troubles caused by the variation in perceptions of risk by different corporate houses. The importance of risk assessment is evaluated through a qualitative research, by putting forward some risk theories. Quantitative approach is also undertaken as the risks are quantified.
financial crisis/ distress as ‘an event in which substantial losses at financial institutions and/or the failure of these institutions cause, or threaten to cause, serious dislocations to the real economy, measured in terms of output foregone.’ Financial malpractices at
The procedures and practices of the risk management model adopted by the bank were inadequate in providing enough control over various price and market risk models it adopted, especially within the chief investment office;
The oversight and governance
The author states that the article is divided into a number of parts each of which has its own speciality. Section 1 looks at the various structures of the modern risk measurement systems. Of particular interest is the position-based risk measurement system that tackles the various drawbacks.
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