CORPORATE TREASURY...on-// CREDIT EXPOSURE HEDGING STRATEGIES 15 Corporate Bonds w/ different...

CORPORATE TREASURY

RISK MANAGEMENT

YON VALTCHEV APRIL 2015

TOPICS

Evolving Focus of Treasury - Risk Management

Breakdown of Financial Risks

Drivers of Financial Risks

Selecting Hedging Strategies

Portfolio Risk Management

TREASURER’S EVOLVING ROLE

Pre-crisis focus

• Narrow operational and support focus on cash and liquidity

Post Financial Crisis Focus

• Focus on Risk Management and Strategic Planning

Funding

Cash & Liquidity

Interest Rate Risk

FX Risk

Commodity Risk

Credit Risk

Corporate Finance

Investor Relations

Insurance

Working Capital

Increased Responsibilities

Funding

Cash & Liquidity

Interest Rate Risk

FX Risk

Core Functions

RISK BREAKDOWN

Business Risk

Strategic Risk Financial Risk

Market Risk

Interest Rates

Commodities

Credit Risk

Country

Industry

Issuer

Counterparty

Liquidity / Solvency

Funding

Liquidity

Operational Risk

COMMON RISK MANAGEMENT CONCERNS

• Where does my exposure come from and how large it is?

• Am I sensitive to the changes of this exposure?

• Should I hedge?

• What are the available hedging strategies?

• At what level and how much should I be hedging?

• Should I be concerned about counterparty risk?

• What are the “Pros” and “Cons” of Clearing vs. paying-away CVA?

• Can I apply “Hedge Accounting” on my hedges?

CREDIT & COUNTERPARTY RISK

Credit Exposure

Risk Measurement

Credit Ratings / Score Cards

Credit Spreads

Future Exposure (EPE/ENE)

Key Financial Ratio

Risk Mitigation

Collateralization / Third Party Guarantee

Diversification

Risk Based Pricing (CVA)

Covenants and Triggers

Credit Risk Hedging

Cleared Instruments

Netting Agreement

DRIVERS OF FINANCIAL RISK

RATES & CREDIT CASE

DRIVERS OF INTEREST RATE EXPOSURE 9

Swap curve underlying

instruments (ICVS)

Swap forwards (FWCM)

SHORT END & LONG END OF THE CURVE 10

IR probabilities by FOMC dates

(short end of the curve) (WIRP)

Bond Yields Survey (long end of

the curve) (BYFC)

CREDIT EXPOSURE DRIVERS 11

Financial leverage &

Earnings volatility

Financial Metrics &

Ratios

Credit Rating &

Outlook

CREDIT MONITORS 12

Top-down credit

monitor

Cross Asset Monitor: CDS,

Equity, Credit Ratings

HEDGING STRATEGIES

INTEREST RATE EXPOSURE HEDGING STRATEGIES

Interest Rate Exposure Hedging Strategies

Hedging Strategy

Options (Caps/Floors/Swaptions)

Cost known upfront.

Depending on market conditions it

might be "cheaper" solution

Option termination value subject

to negotiation

Treasury lock / bond forward /

reverse repo

Forward / Starting Swaps

On the run Treasuries-

most liquid instruments

Off-the-runs are less liquid than

the on-the-runs

Close out calculation subject to

negotiation. Exposed to swap

spread. Subject to CVA charge

Requires active management,

rolling. Subject to Initial &

Variation Margin

Limited tenors, could result in

duration mismatch

Option termination value subject

to negotiation

Might introduce swap spread

basis. Termination value subject

to negotiation

Very Liquid

Cost known upfront.

Depending on market conditions it

might be "cheaper" solution

Interest Rate Swaps

Eurodollar Futures

Treasury Futures

Options (Caps/Floors/Swaptions)

Customizable.

Could be perfect hedge.

CCP clearable or OTC

Very liquid up to 2Y

Liquid - most banks will do

markets.

Cost known upfront

Fully Customizable

Pros Cons

Long/Short Treasuries

& Gov Bonds

Limited Tenors.

Possibility of duration mismatch

CREDIT EXPOSURE HEDGING STRATEGIES 15

Corporate Bonds

w/ different

tenor/securitization

Index CDS (CDX IG/HY)

Peer Bonds

It works to a degree for High Yield

issuers

Not a good strategy for Investment

Grade and Distressed Debt

In some cases liquid instruments in

most developped markets

Spotty Liquidity. Shorts might be

subject to oversight

Equity Derivatives

Spotty Liquidity. Shorts might be

subject to oversight

In some case exhibit better liquidity

than bonds (negative bond basis).

Transparent standart terms. Standard

Refence Obligation (SRO)

Limited universe of active CDS market.

Subject to counterparty risk

Diversified exposure. Very liquid and

transparent pricing. Deep market.

Standard terms & trades electronically.

Removes Counterparty risk

Diversified Exposure with limited tenors

In some cases liquid instruments in

most developped markets

Credit Exposure Hedging Strategies

Hedging Strategy Pros Cons

Liquid instruments in developed

marketsShorts might be subject to oversightSovereign Bonds

HEDGING MARKET EXPOSURE: GM BOND CASE STUDY

HR per instrument (futures /

treasuries) (FIHR)

Hedging Credit and

IR Risk (HGBD)

HEDGING STRATEGY: LIQUIDITY

Avg Daily Volume

Current Volume Avg Hist Vol at Time

Open Interest

Daily Volume

COUNTERPARTY RISK MANAGEMENT -

IRS CASE

COUNTERPARTY RISK: SWAP CASE

CREDIT CHARGES: CVA/DVA

Bilateral credit charge

DVA adjusted MTM

CVA/DVA/ Bilateral

Running Spread

Bilateral Calculation

POTENTIAL FUTURE EXPOSURE – EPE & ENE SPOT AND FORWARD CVA, PFE

INTEGRATED TREASURY RISK

MANAGEMENT

QUANTIFYING MARKET

CREDIT RISK

QUANTIFYING EXPOSURES

Financial Risk

VAR Analysis

Historical VAR

Expected Shortfall / Tail Risk

Marginal & Incremental VAR

Greeks

Duration / Key Rate Risk (DV01, CS01)

Convexity

Scenario Analysis

“What If” / Factor Stress

Scenario Analysis

Historical Events

MARKET RISK: KEY RATE BUCKETING

MARKET RISK (SHOC): STRESS-TESTS

VALUE-AT-RISK: MARS 27

HISTORICAL VAR: EXPECTED SHORTFALL, IMPLICIT CORRELATIONS

Counterparty Risk

Cleared Swaps: Initial Margin (LCH/CME)

(Uncleared) OTC Swaps

0% collateral: CVA / PFE

Partial collateral

100% collateral

(Stringent CSAs)

CREDIT RISK EVALUATION 29

Margin Optimization:

by portfolio netting

- CSA Shopping for

Foreign Banks

- Risky Curve Discounting

- Min Threshold

- Min Transfer Amt

COMPARING CVA CHARGES 30

Assume 5yr Swap with NPV = $1MM

Collateral Posting Frequency CVA Peak Exposure

No Collateral 110,248 1,016,972

Quarterly with 10K Threshold 8,038 88,735

Quarterly 7,391 78,338

Daily Collateral 3,133 28,349

COMPARING CVA CHARGES 31

COMPARING CVA CHARGES: QUARTERLY COLLATERAL POSTING

OIS DISCOUNTING: TO REFLECT RETURN ON COLLATERAL

INITIAL MARGIN OPTIMIZATION 34

Regulation: Swap Trading

Mandatory Clearing

Electronic Venue: SEF

FCM (Bank)

Clearinghouse (LCH/CME)

Mandatory Reporting

REGULATION & ELECTRONIC TRADING 35

ALLQ: SWAPS ELECTRONIC TRADING

SEF -> FCM -> CLEARING

ANNEX: CORE TREASURY TOOLS

ANNEX: TREASURER CORE FUNCTIONALITY (1)

Interest Rates Analysis & Risk Management

RRRA/BSR/FPA – Repo /Treasury Lock/ Bond Forward

SWPM – Interest Rates Derivatives Pricing Engine

WIRP – Short term interest rates probabilities

ICVS – Swap Curve Builder

FWCM – Forward Curve Matrix

FXFA – FX-Interest Rate Arbitrage

WIR – World Interest Rate Futures Monitor

WS – World Swaps Monitor

VCUB / NSV – Volatility Surface

XCF – Cross-Currency Funding / Spread Matrix

Foreign Exchange

WCR – World Currency Rates

FXFC - FX Forecasts

FXFM – FX Rate Forecast Model

FXEX – FX Exposure Capture

OMST- Most Active options strikes and sizes

FRD – FX Forward Calculator

FXIP – FX Information Portal

HWIZ – Hedging wizard

SDRV – Options & NDF transaction volumes

Commodities

FDM – Commodities Fundamentals

CPLY – Commodity playbook by commodity type

CFVL – Commodity fair value

CCRV – Commodity curve analysis

OVML - Option and Forward Analytics (FX/Commodities)

GAS / AGS/ OIL / MINE – Nat Gas/ Agri / Oil / Metals tools

General

BPS – Bloomberg Resource Center – docs, videos workflows

Corporate Finance & Capital Structure

LEAG – Overview of top underwriters

FIW /COMB – Bond portfolio pricing, performance, relative value

LOAN / COV - Loan Monitor & covenant information

TDH – Historical liquidity (spread to bench, trade volumes)

DES – Instrument & Issuer description, schedules, covenants

NIM - New issue monitor

NIA – New issue analytics

DDIS – Debt distribution profile for Corp & Sovereign

CRV/CRVF – Curve construction & Curve depository

YAS – Yield and Spread analysis

WACC - Weighted Average Cost of Capital

CAST – Capital Structure

FA – Financial analysis

EQRV – Equity Relative Value

FIRV – Fixed Income Relative Value

QMGR – Quote manager

IMGR – Inventory & pricing

CACS – Corporate actions calendar

MA / PEM – Mergers & Acquisitions, Private Equity portals

CF – Company filings

Credit Analysis & Risk Management

WCDS – World CDS monitor

FICM – Fixed Income Credit Market

SOVR/SRSK – Sovereign Credit Risk Monitors

DRSK – Market vs. Model Default Risk & Probabilities

DRAM – Bloomberg’s Default Risk Ranking

CDSW – Credit Default Swap Valuation

CDSV – CDS term structure

ANNEX: TREASURER CORE FUNCTIONALITY (2)

Electronic Trading & Hedging Analysis ET/ FIT/ FXGO / TSOX– Electronic trading portal & tools FIT/RFQ/RFQC – Trading quotes for Rates, FX & Commodities RUNZ / IMGR / QMGR – Dealer pricing, inventory and quotes CTM – Futures contract table menu SDR/ SDRV – Swap Data Repository: transaction transparency BEMS – Bloomberg Execution Management System

News & Market Intelligence BI – Industry, sector and company analysis TNI – Advanced news search TOP – Top news READ – Most read news CN – Company specific news FIRS - Economic, industry and markets insight FFM – Functions for the market – practical applications

Search Engines SRCH – Security search CSCH – Convertible search LSRC – Loan search EQS – Equity Screening Investor Relations IR – Investor Relations EE – Earnings Estimate IP – Investor Profile HDS – Company Ownership CAST – Capital Structure AGGD – Debt Holders Documentation, Libraries & MS XL Tools DRVD – Derivatives documentation center XLTP – MS Excel template library FLDS – Bloomberg data field search DLIP – Structured derivatives

Counterparty Analysis & Risk Management

CVA – Credit Valuation Analysis

CRPR – Credit Ratings and Outlook Profile

CCA – Credit Comparable Analysis

RATC – Ratings Change

SPLC – Supply Chain Analysis

Portfolio Risk Management & Valuation Tools

MARS – Multi-Asset Risk & Valuation System

BVLI – Bloomberg Valuation Portal

Hedge accounting

HEFF – Hedge Accounting Effectiveness Testing

Forecasting Tools

ECFC – Economic Forecasts

FXFC – FX Forecasts

BYFC – Bond Yield Forecasts

BDVD – Dividend Forecasts

LEAD – Leading Economic Indicators

CPFC – Commodity Price Forecast

Monitors

MMR – Money market rates monitor

CENB / FED – Central Banks

SOVM/USSW/BTMM/PX1 – Sovereign debt monitors

DMMV/EMMV – Developed/Emerging markets monitors

FCON – Financial conditions monitors

OMON – Options monitor

GV / HGV / SKEW –Volatility analytical tools

OVDV – Volatility surface

WCR – World currency rates

IFMO – Inflation monitor

THANK YOU YON VALTCHEV YVALTCHEV@BLOOMBERG.NET

+1-212-617-1804

CORPORATE TREASURY...on-// CREDIT EXPOSURE HEDGING STRATEGIES 15 Corporate Bonds w/ different...

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