Market Risk Management

FIN ZG 523

Session 1-2
(Contact Hours 1, 2)
Market Participants

Ankit Shah, ACA, CFA

FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Agenda
• Banks

•Asset Managers

•Hedge Funds

•Asset Owners

FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Introductions – Lead
Instructor
Ankit Shah ACA, CFA
• Chartered Accountant, 2007

• Received the CFA charter in 2011 (CFA Institute, USA)

• Over 12years of training experience across Finance and Capital Markets

domain.

• Ongoing industry experience of over 10years having worked with global

firms like Lehman Brothers, Nomura, MSCI and Invesco Asset
Management.

• Entrepreneurship stint running Training business and Outsourcing

company in India.

• Training via multiple channels – classroom, live online, studio recording.

• Multiple training avenues – Training Institutes, B-Schools, University, and

Corporate coaching.

• Contributed articles on Wall Street Oasis, Linkedin.

FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Course Objectives

No

CO1 Gain basic understanding of the how to measure and manage market
risk particularly in the context of banking and financial services
industry.

CO2 Gain good understanding of analytical techniques used in measuring

and managing markit risk including VaR, Expected Shortfall, etc.

CO3 Gain basic understanding of banking regulations relating to Market

Risk and how to apply specialized techniques such as scenario
analysis and stress testing
CO4 Learn the hands-on practical approaches towards measuring,
modeling, and managing market risk

FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Learning Outcome
Statements
No Learning Outcomes

LO1 Learn how to calculate VaR, Expected Shortfall and other important metrics for
measuring and managing Market Risk

LO2 Review valuation basics relating to equities, bonds, and derivatives

LO3 Risk under Regulatory framework with a focus on BASEL and FRTB

LO4 Describe the evolution of risk management regulation and interpret and apply
appropriate techniques for calculation of Economic Capital

LO5 Apply advanced analytical techniques such as scenario analysis, stress testing, etc.

LO6 Demonstrate solutions to "real" risk management problems by employing excel/

financial modeling in an optimal/ effective manner.

LO7 Analyze/ Evaluate real life business/ financial situations and identify/ apply the
appropriate framework/ concepts to solve it in an optimal/ effective manner.

FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Textbook/ Resources

T1 Risk Management and Financial Institutions by John C

Hull, 4th Edition, published by Wiley India

R1 An Introduction to Market Risk Measurement by Kevin Dowd

published by Wiley India
R2 Options, Futures, and other Derivatives, Ninth Edition, by , and
Basu, published by Pearson Education India

R3 For some sections excel based models will be created which is

not covered within the text book. Suggest to refer the models on
the spreadsheet which will be important for experimental
learning part of evaluation.

FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
 Evaluation Scheme

No Name Type Duration Weight Day, Date, Session, Time

EC-1 Quiz-I Online - 5% TBA

Quiz-II Online - 5% TBA

Experiential - 15% TBA

Learning
EC-2 Mid-Semester Closed 2 hours 30%
Test Book
EC-3 Comprehensive Open Book 3 hours 45%
Exam

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Flipped Classroom

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Market Participants

Banks

Asset Managers (Mutual Funds)

Asset Owners (Pension funds, Insurance)

Hedge Funds and Boutique Invt managers

FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Nature of Banking

Commercial banking
▪ Taking deposits, making loans (wholesale or retail)
▪ Money center banks operate in the wholesale market and often fund themselves by
borrowing

Investment banking
▪ Raising debt and equity for companies; advice on mergers and acquisitions,
restructurings, trading, etc

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Structure of Banking in the US

•Large international banks (small number)

•Regional banks (several hundred)
•Small community banks (several thousand)

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
History of Bank Regulation in US (page 27)

•McFadden Act (1927, 1933)

•Douglas Amendment (1956)
•Bank Holding Companies Act (1970)
•Riegel-Neal Interstate Banking and Branching Efficiency Act (1994)

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Example of Simple Bank Balance Sheet: End
2015 (Table 2.2, page 28)

Assets Liabilities
Cash 5 Deposits 90
Subord L.T. Debt 5
Marketable Securities 10
Equity Capital 5
Loans 80
Fixed Assets 5
Total 100
Total 100

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Income Statement: 2015 (Table 2.3, page 29)

Net Interest Income 3.00

Provision for Loan Losses (0.80)
Non-Interest Income 0.90
Non-Interest Expense (2.50)

Pre-Tax Operating Income 0.60

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Year 2016

•What happens in year 2016 if it is the same as year 2015 except that provision for
loan losses is 4.0 instead of 0.8?

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
What if Balance Sheet Had Been More
Aggressive?

Assets Liabilities
Cash 5 Deposits 94
Subord L.T. Debt 5
Marketable Securities 10
Equity Capital 1
Loans 80
Fixed Assets 5
Total 100
Total 100
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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Regulation

•Regulators set minimum levels for the capital a bank is required to keep

•Equity is an example of Tier 1 capital

•Subordinated long term debt is an example of Tier 2 capital

•Regulations – BASEL, FRTB, etc

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Risk appetite for Banks

Based on the information we saw in previous slides we conclude

that Banks have a LOW risk appetite:

Deals with Public savings

Cash flow sensitive (Asset Liability Management)
Highly Regulated
Capital constraints
Provisioning requirements

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
 Asset Managers (Mutual Funds)

• Professional money managers who invest on behalf of others

• Investor base includes Retail and Institutional investors
• Can be single asset focused or multi-asset class approach
• Can offer open-ended or close-ended funds
• Funds publish a NAV value each day – Net Asset Value
• Asset Managers are subject to regulations in terms of Liquidity, Derivative
dealings, Risk, Leverage and Counterparty exposure.

Regulations – UCITS, AIFMD, DoD Frank, MiFID, etc

19 FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
 Investment policy statement (mandate)

• Investment policy statement (IPS) is a statement of portfolio objectives and

constraints

20 FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Asset Manager Fees

• Asset manager charges a management fee as a percent of sum invested

• Management fee is to be paid irrespective of the fund performance

• Additionally, there could also be a entry or exit load fee applicable

• Generally, no performance fee is charged

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Mutual Fund Risks..

• While Asset managers are professional money managers, they are still not
immune to losses in the market

• Risk is mainly governed by IPS or Fund mandate

• There are generally no hard limits on Risk for e.g., risk cannot bee more than
5% of AUM.

• Risk is generally viewed as i) Low, ii) Moderate or iii) High

• Multiple companies are in the business of evaluating the mutual fund

performance on their risk-reward profile among other parameters

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Hedge Funds

• Most aggressive in terms of their strategies

• Higher degree of investment discretion as comparted to asset managers

• Caters to both Retain and Institutional clients

• More specialized in their Investment approach

• Mostly unregulated

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Hedge Fund fees

• A flat management fee is charged

• Performance fee charged, generally to the tune of 20%

• No entry or exit load generally

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Hedge Fund Risks..

• Generally most risky set of Investment managers

• Absolute return focused

• Lack of regulation elevates risk taking appetite

• Lack of thorough mandate dilutes the importance of risk within fund management
exercise

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Asset Owners

• Includes institutes who manage public savings

• Pension funds, sovereign wealth funds, lead this segment

• Asset owners have an inherent objective to preserve capital

• Most of the asset owners have a high local Government supervision

• Subject to regulation

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Asset Owner risks

• Due to capital preservation objective risk appetite is very low

• Government supervision restricts ability for investment discretion

• Generally do not invest in alternative investment

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Market Participant Risk summary

Banks Asset Managers Asset Hedge

Owners Funds
Risk Low for Banking Low, Moderate or Low High
book. High (based on
Moderate for mandate)
Trading book

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
While you are away

• Review the relevant chapters from textbook

• Make sure you have access to laptop/ computer with

Excel; we will need it for experiential learning components
in subsequent classes. (Excel 2007 or later versions
preferred.)

• Email me your expectations from this course:

• ankit.shah@wilp.bits-pilani.ac.in

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Source

Risk Management and Financial Institutions - Copyright © John C. Hull 2015

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FIN ZG 523 – Market Risk Management BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956