Businesses in order to increase the return or to reduce the level of risk associated with product (financial product) are increasingly making use of financial derivates in the respective portfolios. Among the range of derivatives being used in market following few derivatives are most commonly used (Culp, 2011): Futures contracts ( facilitating transfer of asset on future date at an agreed price) Options (Call option or put option facilitates the purchasing or selling option to buyer or seller to an agreed date and price. To mention as the name implies options are not obligations). Swaps (Exchange of cash flow with another cash flows for gaining the required benefit) Hybrid (derivates that mix the features of more than one securities with financial engineering) Using these and others financial product of derivative category suiting to the need of the business as well as individuals financial marketers take advantage of derivatives to develop desired fashion portfolio or value of balance sheet. Derivatives allow hedging of the risks from various domains. Such as market risk, interest rate risk, model risk etc (Functional Finances, n.d). For instance, the interest rate risk can be hedge using derivative such as Interest Rate Swap (IRS) contract. Various risk measurement factors are used to evaluate the risk such as (Hentschel & Smith Jr, 1995): Beta measures the risk in the context of equities. Stock risk is measured in relevance to the market with beta. With respect to bond market, the modified duration assess the risk associated with interest rate risk. Interest rate risk is the relevant risk to bond. Modified risk play similar role for bonds as played by beta for equities. Delta measures the risk of change in value of future, forward or option over shorter period of time owing to the change in asset prices Gamma is a measure of change in delta as the stock prices chances. This is effective for the hedging the change in the delta. Vega measures the relationship between the volatility and options value. Rho is a risk measures for assessing the change in the call option prices with respect to the variation in the risk-free rate. Theta is another measure for the derivatives’ risk measurement. For the change in the value of the option with respect to change in time factors (such as time to maturity) that does not abruptly changes like other factors. Hence single product of derivative (option) offers wide risk factors for hedging and these are from market risk perspectives only. Credit risk, model risk, concentration risk are other risk measures that offers greater variation in risk management for derivatives (Functional Finances, n.d). Therefore, adding derivative and hedging risk from critically valuing above mentioned risk factors can add significant returns to the portfolio while trading off higher risk to lower risk or un-affordable risk to affordable risk. Various measures are useful in various financial conditions and even combination of measures is useful (Homaifar, 2004). For instance, a balanced portfolio (portfolio with fixed income and equity particulars) generates risk from equity segment in order to generate the higher return. In addition as the name signifies, portfolio is balance and has the fixed income
ROLE OF DERIVATIVES IN MANAGING RISK WITHIN A BALANCED INVESTMENT PORTFOLIO Current financial market offers wide range of financial products to take the benefit of increased return as well as controlling risk. Finance professional have been adding value to balance sheets and portfolios with re-engineering the existing products with financial structures…
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.
It was in the year 2008, during the global recession; J. P. Morgan Chase acquired Bear Stearns. Bear Stearns was ranked fifth amongst all American investment banks at the time of its downfall (Source Watch, n.d.). Improper financial risk management was the centre of the reason for its downfall.
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.
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.
5 pages (1250 words)Essay
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