Complex trading activities if:
- The market becomes more liquid and sophisticated
- Banks need to trade the portfolio of instruments more than the customer needs
This prompted the bank to expand its trading portfolio. In these circumstances is very important for banks to consider the control structure to ensure that they are able to manage the risks arising from such trading activity.
Because the bank supervisor procedure provides for freedom of new products, it is important to establish a bank banks granting permission procedures are strict in the entire department of the bank. Procedures for granting a permit must include the following:
- Provision granting permission - whether a bank has a license for a product?
- Impact on capital - how these products affect the capital requirements of banks?
- Taxes - the product will create new tax issues?
- Accounting procedures - whether the product can be accommodated by the bank's procedures?
- Legal procedures and documentation - whether the provisions of law have been met and approved the document?
- IT System-does trade and settlement systems need upgrades?
- Operations - whether the bank can booked and conduct accurate transaction settlement?
- Reporting of risk management - whether the system can find the bank's risk and risk positions melaporan generated by the product?
- Pricing and valuation - whether the procedure price and mark-to-market have been approved?
- The need for funding - whether the product a significant impact on bank funding needs?
- Implications for credit risk - whether the bank has sufficient credit lines to support the product?
- Procedure compliance - whether the product requires a new compliance procedures?
Tuesday, October 20, 2009
Thursday, October 15, 2009
Position Management and Hedging
Market risk does not only occur in trading book but also in the banking book, because the position of the banking book valued exchange rate and the current commodity value. Management interest rates in the banking book is usually done by the Treasury.
Manajem market risk in banking book done by the Treasury the right to take a position until the limit set by the bank. This activity should be strictly controlled and independently to ensure knowing the risks.
Traders manage risk by trading in instruments that match their risk position. This method is not always profitable, so that frequently used hedging techniques. Traders can hedge their risk by taking the right position on the instrument being traded, or on different instruments. These instruments can have different characteristics but the change in market value will reflect the original transaction, so for all dihedge portfolio at the market price changes will result in little or no change in market value of the portfolio. Often a transaction must be some kind of hedge to match.
Trader will conduct hedge with a more liquid instrument of instruments that are traded so that they can perform faster hedgingnya strategy, dealing addition cost would be cheaper for a more liquid market.
The advantage of derivatives (hedging) from cash instruments (such as loans):
- Lower credit risk
- Lower funding needs
- A lower capital charge
- Greater liquidity
- Dealing a lower cost
However, hedging management requires a more careful because the instruments used are not the same as original transaction. There will be some residual risk that is not to be counted tercover and controlled. In a large trading positions, the interaction between hedge and long risk positions can create new risks.
Basis risk is the residual risk of the most significant and occurs in the portfolio with the same transaction. Basis risk is the risk of change in the relationship between the price at the position and price risk instruments used to hedge the risk position. This risk occurs in situations where the market price for each type of instrument has a different but interconnected.
Manajem market risk in banking book done by the Treasury the right to take a position until the limit set by the bank. This activity should be strictly controlled and independently to ensure knowing the risks.
Traders manage risk by trading in instruments that match their risk position. This method is not always profitable, so that frequently used hedging techniques. Traders can hedge their risk by taking the right position on the instrument being traded, or on different instruments. These instruments can have different characteristics but the change in market value will reflect the original transaction, so for all dihedge portfolio at the market price changes will result in little or no change in market value of the portfolio. Often a transaction must be some kind of hedge to match.
Trader will conduct hedge with a more liquid instrument of instruments that are traded so that they can perform faster hedgingnya strategy, dealing addition cost would be cheaper for a more liquid market.
The advantage of derivatives (hedging) from cash instruments (such as loans):
- Lower credit risk
- Lower funding needs
- A lower capital charge
- Greater liquidity
- Dealing a lower cost
However, hedging management requires a more careful because the instruments used are not the same as original transaction. There will be some residual risk that is not to be counted tercover and controlled. In a large trading positions, the interaction between hedge and long risk positions can create new risks.
Basis risk is the residual risk of the most significant and occurs in the portfolio with the same transaction. Basis risk is the risk of change in the relationship between the price at the position and price risk instruments used to hedge the risk position. This risk occurs in situations where the market price for each type of instrument has a different but interconnected.
Saturday, October 10, 2009
Development of Trading Activities
The purpose of a bank to buy and sell financial instruments is to obtain short-term profits from market price movements → means the bank at risk for loss if the value of financial instruments are down.
Banks may adopt one of three trading strategies:
1. Matched Book → lowest market risk
Bank to match the customer's position directly on the same amount and opposite positions are traded both internally and with other banks → terhadi at risk only when the deal with customers and transact offset (or is called 'hedging' or 'covering' transactions).
2. Manage product positioning by making appropriate hedging or covering from the trading desk policy.
Trading desk has a limit for market risk limit the risk that belongs to the bank every time. The position can be taken because the transaction because the customer or a trader to take positions in the market. This strategy allows the trader to calculate their position to take advantage of market price movements.
3. Being a 'market maker' for a product.
Traders will give buy and sell prices to customers and other banks and memperdagangkannya at the relevant price level. This strategy is running when the market is illiquid and other market makers with whom a trader can cover the risks. Market makers can benefit from:
→ spreads between buy and sell prices
→ market information obtained from each transaction
Risk in this strategy is that the trader must take a position that can cause harm. So traders have to be disciplined in managing risk and the bank should establish and monitor a suitable limit.
Banks tend to change its strategy if the business grows and there will be more than one strategy used in the product in a bank's trading book. Usually a bank trading activities arising from the desire to provide service to customers. As the development bank's trading activities in the forex market is one of the freely traded market in the world. This comes from the introduction of floating exchange rates in the 1970s, which created new risks for customers who do international business, so they asked the bank to do forex trading for them.
The exchange rate is a retail rate offered to customers including the wholesale margin of the interbank market rate. At the beginning of a very large margin trading, but as banks increase in volume and more confident in their ability to manage their foreign exchange positions, the trading activities of the service changes to be nasbah wholesale trading operation.
The banks with lots of customers and large volume of forex transactions can use the position of 'retail' is to influence short-term movements in the forex market, and can bring opportunity to profit far exceeds the customer's transaction. That's why banks to improve your position on his trading book. When competition increases, margins will drop to the customer, so the volume of trade for the world's major currencies such as USD / EUR, USD / JPY and EUR / GBP currently dominated by interbank trade, while trade is relatively small customer.
The development of foreign exchange is a good illustration of how trade an instrument to grow in a bank.
stage 1: the bank maintains a position of the instrument match the → the bank to do deal with customers and soon to hedge with another bank. Bank profit obtained from the difference between interbank rates and the price customers
stage 2: the bank holding the position of customer transactions, waiting for a short-term market movements are profitable banks. Holding period can be extended if the bank more experienced. Bank's trading activity does not depend anymore on customer activity
Banks may adopt one of three trading strategies:
1. Matched Book → lowest market risk
Bank to match the customer's position directly on the same amount and opposite positions are traded both internally and with other banks → terhadi at risk only when the deal with customers and transact offset (or is called 'hedging' or 'covering' transactions).
2. Manage product positioning by making appropriate hedging or covering from the trading desk policy.
Trading desk has a limit for market risk limit the risk that belongs to the bank every time. The position can be taken because the transaction because the customer or a trader to take positions in the market. This strategy allows the trader to calculate their position to take advantage of market price movements.
3. Being a 'market maker' for a product.
Traders will give buy and sell prices to customers and other banks and memperdagangkannya at the relevant price level. This strategy is running when the market is illiquid and other market makers with whom a trader can cover the risks. Market makers can benefit from:
→ spreads between buy and sell prices
→ market information obtained from each transaction
Risk in this strategy is that the trader must take a position that can cause harm. So traders have to be disciplined in managing risk and the bank should establish and monitor a suitable limit.
Banks tend to change its strategy if the business grows and there will be more than one strategy used in the product in a bank's trading book. Usually a bank trading activities arising from the desire to provide service to customers. As the development bank's trading activities in the forex market is one of the freely traded market in the world. This comes from the introduction of floating exchange rates in the 1970s, which created new risks for customers who do international business, so they asked the bank to do forex trading for them.
The exchange rate is a retail rate offered to customers including the wholesale margin of the interbank market rate. At the beginning of a very large margin trading, but as banks increase in volume and more confident in their ability to manage their foreign exchange positions, the trading activities of the service changes to be nasbah wholesale trading operation.
The banks with lots of customers and large volume of forex transactions can use the position of 'retail' is to influence short-term movements in the forex market, and can bring opportunity to profit far exceeds the customer's transaction. That's why banks to improve your position on his trading book. When competition increases, margins will drop to the customer, so the volume of trade for the world's major currencies such as USD / EUR, USD / JPY and EUR / GBP currently dominated by interbank trade, while trade is relatively small customer.
The development of foreign exchange is a good illustration of how trade an instrument to grow in a bank.
stage 1: the bank maintains a position of the instrument match the → the bank to do deal with customers and soon to hedge with another bank. Bank profit obtained from the difference between interbank rates and the price customers
stage 2: the bank holding the position of customer transactions, waiting for a short-term market movements are profitable banks. Holding period can be extended if the bank more experienced. Bank's trading activity does not depend anymore on customer activity
Monday, October 5, 2009
The Nature Of Market Risk
Market risk is the risk of loss of position on and off-balance sheet due to market price movements.
Banks that have a position on the balance sheet financial instruments exposed to market risk
Banks that act as an intermediary in a transaction that is not posted on the bank's balance sheet is not exposed to market risk on these transactions
Market risk consists of:
Specific Risk → risk of price movements of securities due to factors relating to the securities or issuernya. Example: the price of a bond falls due from the issuer credit rating deteriorated → affect the bond of the issuer but does not affect the bonds in general.
General Market Risk → risk of market price movements of the entire instrument. Example: reduction in central bank interest rates caused a decrease in market interest rates, which will affect the value of all instruments related to interest rates.
General market risk is divided into 4 major categories for analysis purposes:
- Interest rate risk → potential losses due to changes in interest rates, calculated on all instruments that use one or more yield curves to calculate a market value.
- Equity position risk → potential losses due to changes in stock prices, which applied to all instruments that use stock as part of the assessment.
- Foreign exchange risk → potential losses due to exchange rate movements. This risk applies to all products and position in the exchange rate has a different value of the exchange rate used by banks in reporting.
- Commodity position risk → potential losses due to commodity price changes, apply to all commodities and derivatives.
All of the above risk categories do not stand alone because of changes in the value of a risk will affect the types of other market risks.
There are other types of market prices associated with derivatives trading, such as volatility rates, which have the same risk profile as the above categories.
The market price is influenced by several factors namely:
- Supply and demand of a product will affect the price level in the short term because the market makers adjust prices to take advantage.
- Liquidity can affect the market price
Liquid market → there are a lot of market makers and high-volume business → small profit → dealing costs for small traders.
Illiquid market → bigger profits and trade less actively
Liquid markets may become illiquid before the holiday or any announcement relating to the economy.
- Intervention by the monetary authorities can affect the market price for quick short-term.
- Arbitrage (where a market price set by one or more other market prices), will affect the daily price movements.
- Political and economic events along with natural disasters can affect the market price for a dramatic short-term (both locally and internationally).
- Underlying economic factors are the strongest drivers of long-term market prices.
Banks that have a position on the balance sheet financial instruments exposed to market risk
Banks that act as an intermediary in a transaction that is not posted on the bank's balance sheet is not exposed to market risk on these transactions
Market risk consists of:
Specific Risk → risk of price movements of securities due to factors relating to the securities or issuernya. Example: the price of a bond falls due from the issuer credit rating deteriorated → affect the bond of the issuer but does not affect the bonds in general.
General Market Risk → risk of market price movements of the entire instrument. Example: reduction in central bank interest rates caused a decrease in market interest rates, which will affect the value of all instruments related to interest rates.
General market risk is divided into 4 major categories for analysis purposes:
- Interest rate risk → potential losses due to changes in interest rates, calculated on all instruments that use one or more yield curves to calculate a market value.
- Equity position risk → potential losses due to changes in stock prices, which applied to all instruments that use stock as part of the assessment.
- Foreign exchange risk → potential losses due to exchange rate movements. This risk applies to all products and position in the exchange rate has a different value of the exchange rate used by banks in reporting.
- Commodity position risk → potential losses due to commodity price changes, apply to all commodities and derivatives.
All of the above risk categories do not stand alone because of changes in the value of a risk will affect the types of other market risks.
There are other types of market prices associated with derivatives trading, such as volatility rates, which have the same risk profile as the above categories.
The market price is influenced by several factors namely:
- Supply and demand of a product will affect the price level in the short term because the market makers adjust prices to take advantage.
- Liquidity can affect the market price
Liquid market → there are a lot of market makers and high-volume business → small profit → dealing costs for small traders.
Illiquid market → bigger profits and trade less actively
Liquid markets may become illiquid before the holiday or any announcement relating to the economy.
- Intervention by the monetary authorities can affect the market price for quick short-term.
- Arbitrage (where a market price set by one or more other market prices), will affect the daily price movements.
- Political and economic events along with natural disasters can affect the market price for a dramatic short-term (both locally and internationally).
- Underlying economic factors are the strongest drivers of long-term market prices.
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