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“ TRANSFORM RISK INTO VALUE.... ”
Effective Financial Asset Effective Financial Asset Management & Trading with Management & Trading with VaRVaR
DusitDusit DomethongDomethongVice President, ThaiBDC
Pornpan Pornpan SakulsrivichaiSakulsrivichaiAssistant Manager, ThaiBDC
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OutlineOutline1. Introducing to VaR concept2. How to apply VaR in Asset Management & Trading
2.1 Financial Risk ManagementExposure and VaR limit
(by applying asset allocation and selection techniques)Market Risk Charge Correlation Break Down
2.2 Portfolio Management and PerformanceRAROCRisk Attribution
2.3 VaR application to Non-Financial Sectors 3. Conclusion
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• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
What is VaR?
VaR summarizes the worst loss over a target horizon with a given level of confidencee.g. Max loss of 1-day holding period at 99% confidence level.
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• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
VaRVaR is just the is just the leftleft side of the pictureside of the picture..What is theWhat is the rightright sideside??
Fx Portfolio's 10-day Profit & Loss (Additive Approach)
05
1015
2025
P&L
Freq
uenc
y
0.00000
0.00010
0.00020
0.00030
0.00040
Prob
abilit
y
Histogam's Frequency (Left) Probability of P&L (right)
Danger Opportunity
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Backward-looking Question:How much we gained today?
Forward-looking Question:How much could we lose tomorrowHow much could we lose tomorrow??a) xxxx,,xxxxxx BahtBaht But how could you know about
tomorrow?b) VaRVaR is the answer!
• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
VaRVaR DefinitionDefinitionSuppose we just closed our positions of all trading Suppose we just closed our positions of all trading portfoliosportfolios.. Then answer the following questionsThen answer the following questions..
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• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
How to apply How to apply VaRVaR in Asset in Asset Management & TradingManagement & Trading
Financial Risk ManagementExposure and VaR LimitTop management can apply Financial Risk Concept to
control and monitor organization’s risk from top-down and set policy by using VaR as a tool.
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• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
Exposure and Exposure and VaRVaR LimitLimit
• Ex Trading portfolio of company A comprises of 3 asset types; Bonds, Equities and Foreign Currencies.
• CFO assigns policy regarding Exposure and VaR Limit as follows;– Portfolio exposure not exceeds Bt. 300 mln.– Portfolio VaR not exceeds Bt. 10 mln. at holding period 10 days
and confidence level at 99%. • How to follow this policy by using iRisk3.0
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• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
Exposure and Exposure and VaRVaR LimitLimitAssume that existing position on May 16, 2005 as follow;
2,000,000MYR10,000,000SSI20,000PTT116A5
900,000SGD200,000ADVANC20,000ATC106A4
300,000GBP2,500,000ITD20,000EGAT127A3
400,000EUR100,000PTT20,000LB22NA2
500,000USD200,000BBL20,000LB08DA1
UnitSymbolUnitSymbolUnitSymbolNo.
Foreign CurrencyEquityBond
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• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
Exposure and Exposure and VaRVaR Limit Limit
Portfolio exposureexceeds Bt. 300 mln
Portfolio VaR also exceeds Bt. 10 mln.
iRisk3.0
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• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
Exposure and Exposure and VaRVaR LimitLimit
Traders can handle this case in many alternatives based on their strategies i.e.
Portfolio Management(Asset Allocation and Selection)
Use hedging toolsetc.
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• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
Exposure and Exposure and VaRVaR Limit Limit
iRisk3.0 Use Individual and Component VaR as a toolfor Portfolio Adjustment
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Possible ways to manage portfolio by using useful information from iRisk3.0 results
Selling ITD totallyAllocate bonds, equities and FX positions to follow the policy But if we sell LB22NA, what situation will be occurred?Let’s try to find solution by iRisk3.0
Exposure and Exposure and VaRVaR Limit Limit
• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
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• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
Exposure and Exposure and VaRVaR Limit Limit The examples of possible results unit: Mln. Bht.
12.16(Former VaR was
12.13)
296.93But if selling LB22NA
8.60276.79Selling BBL+PTT totally
8.29293.84Selling ITD totally
VaR Limit(Not exceed Bht. 10 Mln)
Exposure Limit(Not exceed Bht.300 Mln)
Alternatives
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• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
How much market risk capital does a How much market risk capital does a Financial company need? Financial company need?
The international guideline established by the Basel AccordDetermine capital charge as a buffer of riskMarket Risk Charge (MRC) consists of
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MRCt = Max [ k*1*Σ VaRt-i , VaRt-1 ] + SRCt60 i=1
where k represents multiplicative factor and the plus factorSRC represents the specific risk charge
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• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
Market Risk Charge applied with Market Risk Charge applied with iRiskiRisk60
MRCt = Max [ k*1*Σ VaRt-i , VaRt-1 ] + SRCt60 i=1
Back Testing methodDaily VaR Calculation
4.00≥10Red
3.403.503.653.753.85
56789
Yellow3.000 to 4Green
kNo. of Exceptions
Zone
From Back testingPlus factor
0 to 1Qualitative Risk measurement
Multiplicative factor Value between 3 to 5
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• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
Correlation BreakdownCorrelation Breakdown
• Sometimes correlation between assets are not similar to the past i.e. having the Economic Crisis,Political and Leader Change, Natural Disaster (Tsunami) even Terrorism.
• Stress test by adjusting asset correlation is needed to handle the abnormal situation.
• iRisk3.0 allows users to calculate VaR by changingcorrelation based on their assumptions.
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• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
Correlation BreakdownCorrelation Breakdown
Stress test by AdjustingVolatility and Correlation
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33.0921.77Portfolio VaR
CorrelationBreakdown
ρ= 0.51.5xVol
Normal correlation(Bank, USD)ρ = −0.245512
Correlation BreakdownCorrelation Breakdown
• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
Assume that portfolio has 2 assets; BBL 2,000,000 units and USD 500,000 unit
unit: Bht. Mln
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Conventional Performance Conventional Performance Measurement: BalanceMeasurement: Balance--sheet Analysissheet Analysis
• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
RETURN• FIXED ASSETS• FINANCIAL ASSETS• OTHERS
ASSETSRETURN ON ASSET (ROA)
CAPITAL RETURN ON CAPITAL (ROC)SUBORDINATEDDEBT
EQU
ITYCAPITALRESERVE RETURN ON EQUITY (ROE)
CAPITAL
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RAPMi = ProfitiVaRi
RAROC
RAPM1
RAPMi = Net ReturniComponent CaRi
RAPM2
Development to Modern RDevelopment to Modern RAROCAROC
• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
RAROC = Net Earning Economic Capital
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• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
Portfolio Performance MeasurementPortfolio Performance Measurement
RAROC (Risk- adjusted Return on Capital)Initiated by Bankers Trust, 1970Mostly used to measure economic profit and performance measurement in banks and finance
RAROC = Net Earning . Economic Capital at Risk
Operational Risk
Liquidity Risk
Credit RiskMarket Risk
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BondBondLB08DALB08DALB22NALB22NA
ATC106AATC106AEGAT127AEGAT127APTT116APTT116A
EquityEquityBBLBBLPTTPTTITDITD
ADVANCADVANCSSISSI
USDUSDEUREURGBPGBPSGDSGDMYRMYR
FxFx
100,000,000
100,000,000RAROC for Fund Allocation RAROC for Fund Allocation
• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
100,000,000
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• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
How do we compare Portfolio Performance?How do we compare Portfolio Performance?
11.5813.71
2.68
1.09
1531
54
2035
100 100
12.09
1.70
20.5
4.5
25
100
RAROC
VaR
Net Earning
Cost of Fund
Gross Income
Initial Investment Fund
Bond Equity Fx
11.58
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• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
Portfolio ReallocationPortfolio Reallocation1 LB08DA 17,500 1 BBL 200,000 1 USD 500,000 2 LB22NA 17,500 2 PTT 100,000 2 EUR 450,000 3 EGAT127A 17,500 3 ITD 2,110,000 3 GBP 280,000 4 ATC106A 25,000 4 ADVANC 200,000 4 SGD 800,000 5 PTT116A 17,500 5 SSI 9,000,000 5 MYR 1,800,000
100,000,000 100,000,000 100,000,000
Bond Port Equity Port Fx Port
Market Value Market Value Market Value
1 LB08DA 20,000 1 BBL 100,000 1 USD 800,000 2 LB22NA 20,000 2 PTT 100,000 2 EUR 500,000 3 EGAT127A 20,000 3 ITD 2,000,000 3 GBP 300,000 4 ATC106A 23,000 4 ADVANC 200,000 4 SGD 800,000 5 PTT116A 20,000 5 SSI 7,500,000 5 MYR 750,000
110,000,000 85,000,000 105,000,000
Bond Port Equity Port Fx Port
Market Value Market Value Market Value
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RAROC & Portfolio AdjustmentRAROC & Portfolio Adjustment• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
2.6012.09
1.70
11.89
1.81
21.5
4.5
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105
RAROC
VaR
Net Earning
Cost of Fund
Gross Income
Initial Investment Fund
Fx2
3.01
30.5
3.95
14.26
1.23
17.5
5.5
2334
110 85
Bond2 Equity2
9.96
300
Total Port1
300
Total Port2
5.37
12.38
66.5
13.5
80
7.108
9.715
69.05
13.95
8313.71
1.09
15
5
20
100
Bond1
11.58
2.68
31
4
35
100
Equity1
11.5812.09
1.70
20.5
4.5
25
100
Fx1
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• Introduction to VaR• Financial Risk Management• Portfolio Management and Performance
Risk AttributionRisk Attribution• When we need to look closer in each asset portfolio• How much do we can reduce VaR ?• For example,
Bank sectorBank sector
Property sectorProperty sector
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Besides financial sector, VaR is also taking hold in the corporate world i.e.
Import and Export-Related Business Manufacturing Industry Transportation Industry Energy Industry Propertyand so on.
VaRVaR application to other industriesapplication to other industries
• VaR applications• Conclusion
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• VaR applications• Conclusion
VaRVaR application to other industriesapplication to other industries
Ex Import-Export BusinessCompany A imports chemical products from USA amount USD 3 mln. and will has a payment settlement in next 10 days.
There are 3 major alternatives as follows;– Buying at spot rate today– Wait to Buy at spot rate in next 10 days– Buying derivatives i.e. forwards or options.
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• VaR applications• Conclusion
VaRVaR application to other industriesapplication to other industries
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• VaR applications• Conclusion
VaRVaR application to other industriesapplication to other industries
Buy USD at spot ratetoday
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• VaR applications• Conclusion
VaRVaR application to other industriesapplication to other industries
Max reserve for Probability of Baht devaluation inNext 10 days
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• Hence if company A choose the alternative 2, it should reserve the money for payment settlement approximately;
= Baht value at spot rate + VaR for next 10 days(position on 16 May 05)
= 118,883,700 + 2,342,783
= 121,226,483 Baht
VaRVaR application to other industriesapplication to other industries
• VaR applications• Conclusion
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Bt. 123 Mln.
VaRVaR application to other industriesapplication to other industries• VaR applications• Conclusion
Extreme opportunity loss would be occurred approx. = Bt. 4 Mln.
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• VaR applications• Conclusion
Conclusion: Evolution of Conclusion: Evolution of VaRVaR ApplicationApplication
Reporting Risk• Disclosure to shareholders• Management Reports• Regulatory requirements
• Passive
Controlling Risk• Setting Risk Limits(Desk level and firmwide)
• Defensive
Allocating Risk• Performance evaluation• Capital allocation• Strategic Business Decision
• Active
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