Financial Risk Management 2600-IADdzZRFkf

1. The concept of financial risk and an overview of risk measures
• Risk versus uncertainty; identifying exposures and financial risk factors.
• Volatility measures: variance, standard deviation and downside deviation.
• Downside risk measures: Value at Risk (VaR) and Expected Shortfall (ES).
• Sensitivity measures: beta, modified duration, DV01 and the Greeks.
• Selecting a measure appropriate to the exposure, analytical horizon and risk management objective.
• Limitations of risk measurement and interpretation.
2. Volatility measures - selection, interpretation and measurement reliability
• Total volatility and downside deviation relative to a specified threshold.
• The effects of window length and observation weighting on volatility estimates.
• Data frequency, return aggregation and limitations of volatility scaling over time.
• Measuring volatility using closing prices and intraday price ranges.
• The effects of data quality, corporate actions and extreme observations on results.
• Selecting a measure appropriate to the characteristics of the instrument and the analytical objective.
3. Downside risk measures - VaR, ES and Monte Carlo simulation
• Interpreting VaR and ES; the significance of the confidence level and risk horizon.
• Estimating VaR and ES using historical and parametric methods.
• Monte Carlo simulation: specifying assumptions, generating scenarios and deriving the loss distribution.
• The effects of assumptions about return distributions and volatility on risk estimates.
• Out-of-sample evaluation of VaR forecasts: the frequency and clustering of exceedances.
• Stress testing as a complement to downside risk measures.
4. Forward contracts - valuation and hedging foreign exchange risk
• Determining forward exchange rates using interest rate parity; interpreting forward points.
• Distinguishing between the forward exchange rate and the value of a forward contract.
• Valuing an existing contract before settlement.
• The sensitivity of contract value to changes in the spot exchange rate, interest rates and time to settlement.
• Matching the direction, notional amount and maturity of the contract to the hedged exposure.
• Joint assessment of the contract and the hedged cash flow; consequences of hedge mismatches or changes in the expected payment.
5. Swaps - valuation and hedging interest rate risk
• Determining the par interest rate swap rate using interest rate curves.
• Valuing an existing IRS as the difference between the present values of its two legs.
• The roles of the projection curve and the discount curve.
• The sensitivity of swap value to shifts and changes in the shape of the interest rate curve.
• DV01 as a monetary measure of sensitivity to a one-basis-point change in interest rates; matching hedge sensitivity to the exposure.
• Risks arising from mismatches in maturities and reference rates; specific features of cross-currency interest rate swaps.
6. Option valuation and sensitivity analysis
• The Black–Scholes–Merton model: assumptions, applications and limitations.
• The binomial model and incorporating the possibility of early option exercise.
• Determining implied volatility; interpreting the volatility smile and skew.
• Delta, gamma, vega, theta and rho as measures of option value sensitivity.
• Approximating changes in option value using delta and gamma.
• Hedging option exposure using the underlying instrument; limitations of dynamic hedging.
7. Option strategies in risk management
• Selecting a strategy appropriate to the exposure, hedging objective and acceptable loss.
• Straddles and strangles as strategies for taking exposure to volatility.
• The combined sensitivity of a strategy to the underlying price, volatility and the passage of time.
• Assessing costs, break-even points and potential losses; distinguishing between profit or loss at expiry and strategy value before expiry.