Applied Risk Management

Course details

This course is designed to introduce participants to the bank’s most important derivative products and markets. Participants learn about quoted market instruments including FX, interest rates, equities, commodities, as well as options and volatilities for each product type.

In addition to product and market knowledge, the course discusses in detail the metrics used by the bank to control counterparty credit risk. This normally includes understanding how volatility is the “source” of counterparty credit risk, how volatility is measured and how the bank uses it to “forecast” the amount that its clients could owe it.

The above topics are reinforced by means of real deal case studies designed to show how the risks are measured using real life examples.

Learning Approach

• Course Introduction
• Welcome
• Course objectives and history
• Introductions
• Market prices, rates and volatilities

PSE, PSLE and CVA Overview

• Bank positive fair market value
• FX, interest rate swaps, options, commodities
• Monte Carlo approach to PSE, PSLE and CVA
• Volatility as the main driver of counterparty risk
• Credit Valuation Adjustments
• PSE and PSLE Exercise

Interest Rate Swaps

• Introducing swaps and their main uses
• Swap rates and yields
• Building the swap pricing curve
• Discount factors calculated from the swap curve
• Libor forward rates
• Swap pricing
• Fair market value for swaps

Day 2

Interest Rate Swap Case Study

• Floating rate borrower
• Inception value
• Swap P&L as rates change
• How the bank accounts for the swap P&L

Volatility

• Volatility from price changes
• Log-normal modeling of prices and rates
• Comparing real life with the bell curve
• Volatility smiles and smirks
• Volatility term structure
• “Forecasting” future rate moves using volatility

Understanding Risk Measures

• Fair market value (FMV)
• Changes in FMV as the source of risk
• Value at Risk (VaR)
• Pre-settlement exposure (PSE)
• Pre-settlement loan equivalent (PSLE)
• Credit Valuation Adjustments (CVA)
• Calculating risk measures in an interest rate swap
• Obtaining and understanding the classic humped credit risk profile in an interest rate swap

Day 3

• Options
• Long and short calls
• Long and short puts
• Payoffs to the buyer and the seller
• Options and “the money”
• Comparing in-, at- and out-of-the-money
• American, European and Bermudan options
• Intuitive approach to option valuation

FX Products

• Money markets and foreign exchange
• FX trading and market size
• Base and terms currencies
• Non Deliverable Forward (NDF) for an exporter
• Understanding the trade
• Financial controls
• Market risk and VaR
• Counterparty credit risk and PSE/PSLE
• Right way and wrong way exposure
• FX option for an exporter
• Understanding the trade
• Financial controls
• Market risk and VaR
• Counterparty credit risk and PSE/PSLE
• Right way and wrong way exposure

Foreign Exchange Exercises

• Cross currency swap
• Cross currency swap right way and wrong way exposure
• Exporter uses options to construct hedges
• Basket FX options and PSE
• Exporter multi-month exposure, forwards, par forwards and options and dynamics of PSE

Commodity Derivatives

• Energy derivative markets and products
• Client profiles
• Client hedging activity

Commodity Exercises

• Copper caps and floors
• Client short oil floors and PSE
• Jet fuel floor structures and PSE
• More copper swaps, caps and floors
• Oil-linked bank debt

Credit Risk Mitigation Techniques

• Collateralization
• Re-couponing
• Early termination
• Case studies for each risk mitigant

Learning Objectives

At the end of the training, participants will be able to:

• Match products to clients and client needs
• Identify the sources of risk in the deals they propose or approve
• Assess the appropriateness of a trade for a specific client
• Apply the logic of counterparty credit risk to derivatives on various underlying instruments
• Read terms sheets and ask intelligently, “What would have to happen in the market for this client to owe our bank more than they can pay?”