Managing Derivatives Risk

3 days
Prague, NH Hotel Prague
  • Overview of Derivatives and their Key Risks
  • Managing Market Risk in Derivatives Transactions
  • Controlling Credit & Counterparty Risk in Derivatives
  • Measuring and Managing CVA Risk
  • Moving to CCP Clearing of OTC Derivatives
  • Liquidity Risk in Derivatives
  • Managing Operational Risks of Derivatives
  • Mitigating Legal and Reputational Risk in Derivatives
The purpose of this course is to give you a good and practical understanding of the risks encountered in derivatives transactions and of the methods and tools for managing these risks both on an individual and on an aggregate level.

We start by identifying and defining the major risk groups within derivatives and discuss how they inter-relate.

Subsequently we review and analyze the risk structure of key derivatives covering both exchange traded and OTC derivatives and we analyze how the risks differ from instrument to instrument.

We then look at how market risk in derivatives can be measured and managed. We identify and analyze the different types of market risk. We show how the market risk can be measured individually and on a portfolio level using Value-at-Risk and we discuss the mapping of a large portfolio to key risk factors.

Further, we look at how credit & counterparty risk can be measured using a simple add-on method and a more comprehensive "potential future exposure" method. We explain how counterparty risk can be effectively managed using active counterparty credit monitoring, counterparty position limits, margining and collateral. We explain and demonstrate how to measure and manage the "new" risk type, CVA risk, and we discuss how counterparty and CVA risk can be reduced or even eliminated by moving to CCP clearing of OTC derivates.

We continue by looking at liquidity risks of derivatives where key measures include open interest, volume and swap spreads. We discuss transactional liquidity risks of derivatives as well as liquidity shocks and so-called liquidity "Black Holes". We also explain how the liquidity impact of margin calls can be assessed, and we discuss the consequences for liquidity of the move to centralized clearing (CCP).

Finally we look at other risks involved in derivatives transactions with special emphasis on operational risk and legal & reputational risk.

Within operational risk we focus at the key challenge with derivative risk models and the robustness of mitigating techniques. We also give an overview of sound practices for managing operational risk.

Within legal & reputational risk we look at why the legal risks of derivatives are unique from traditional banking products. We explain how to associate costs with legal risks and show how legal & reputational risk can be modelled and used for limit setting. Finally, we discuss how to mitigate legal & reputational risk by fostering a "know your client" culture within the bank.

09.15 - 12.00 Derivatives and their Characteristics

  • Building Blocks of Derivative Products
  • Key Features of Derivative Transactions
  • Identifying and Defining Major Risk Groups
  • Famous Derivative Failures
  • New Derivatives Regulation

A Closer Look at Derivatives and their Key Risks

  • Forward Contracts
  • Futures Contracts
    • Assessing Delivery Options (CTD etc.)
  • Interest Rate and FX Swaps
  • Interest Rate Options
  • Equity and FX Options
  • Exotic Options
  • Structured Products
  • Credit Derivatives
  • Securities Lending
  • Practical Examples and Small Exercises

12.00 - 13.00 Lunch

13.00 - 16.30 Measuring and Managing Market Risk in Derivatives

  • Types of Market Risk in Derivatives
    • Directional and Spread
    • Volatility and Correlation
  • The Components of Market Risk
  • Measuring Equity Risks of Derivatives
    • The Cost of Carry Model (Equity Futures)
    • Measuring Option Sensitivities (“Greeks”) Using the Black-Scholes
    • “Greeks” the CRR and other Numerical Option Pricing Models
  • Managing Market Risks in a Portfolio of Equity Derivatives
    • Hedging Delta, Gamma and Vega Risks
    • Using Structured Products to Transfer Risk
  • Practical Examples and Small Exercises

Day Two

09.00 - 09.15 Recap

09.15 - 12.00 Measuring and Managing Market Risk in Derivatives (Continued)

  • Measuring Interest Rate Risk of Derivatives
    • Decomposing FRAS, Futures, Swaps and Interest Rate Options
    • Calculating Key Rate Duration and VaR
  • Managing Risks in a Portfolio of Interest Rate Derivatives
    • Hedging Delta, Gamma and Vega Risks
  • Measuring and Managing FX Risks of Derivatives
    • Decomposing FX Swaps and Options
    • Assessing and Hedging the FX Risk on an NPV Basis
    • Hedging FX Option Risk
  • Managing Total Derivatives Market Risks using a Risk Warehouse Principle
  • Practical Examples and Small Exercises

12.00 - 13.00 Lunch

13.00 - 16.30 Measuring and Managing Credit & Counterparty Risk in Derivatives

  • Main Types of Credit & Counterparty Risk in Derivatives
    • Pre-settlement and Settlement Risk
    • Payment Timing Mismatch Risk
    • CVA Risk
  • Exposures Definitions
    • Current Exposure + Add-On
    • Modelling Potential Future Exposure
    • Modelling CVA Risk
  • Credit & Counterparty Risk Mitigation Techniques
    • Master Agreement + CSA
    • Counterparty Monitoring and Limits
    • Early Termination of Deals and Netting
    • Collateral, Resets and Thresholds
  • The Move to CCP Clearing and How It Will Affect Derivatives Risk
  • Practical Examples and Small Exercises

Day Three

09.00 - 09.15 Recap

09.15 - 12.00 Measuring and Managing Liquidity Risk in Derivatives

  • Measuring Liquidity of Derivative Markets
    • Open Interest and Volume
    • Liquidity and Swap Spreads
    • The Libor-OIS Spread
    • The Dollar Squeeze and Basis Swap Spreads
  • Transactional Liquidity Risk in Derivatives
    • Secondary Market, Initial and Variation Margin
  • Market Liquidity Risk in Derivatives
    • Liquidity Shocks and Liquidity “Black Holes”
  • Measuring and Managing the Liquidity Risk Arising from Margin Calls
    • Margin Threshold and Margin Calls
    • How the Move to CCP will Affect Margining and Liquidity
  • Practical Examples and Small Exercises

12.00 - 13.00 Lunch

13.00 - 16.30 Managing other Derivatives Risks

  • Operational Risk
    • Model Risk
    • Robustness of Mitigating Techniques
    • Sound Practices for Managing Operational Risk
  • Legal and Reputational Risk
    • Types of Legal and Reputational Risks
    • Why Are the Legal Risks of Derivatives Unique from Traditional Banking Products?
    • What are the Costs of Legal Risk?
    • Modelling Legal Risk and Reputational Risk
    • Defining and Working with Legal Risk Limits
    • Fostering a “Know your Customer “ Culture

Evaluation and Termination of the Seminar

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