TRMMod IV
TRMMod IV
TRMMod IV
Not only in business even in our normal life we find deviation in what we expect and what we achieve Future - uncertain and unpredictable
Risk
These are the uncertainties resulting in adverse outcome in relation to planned objective/ expectation. Financial, Interest Rate, Credit, Liquidity etc Any factors that affects the cash inflow or outflow affects the profitability and the financial position.
Increase- cost of inputs- profit falls Increase in trans cost- profit falls Decrease in taxes- profit rises Increase in cost of living- sales volume decreases
Risk Management
It is a two step process- determining what risks exist in an investment and then handling those risks in a way best suited to your investment objectives.
Risk and Capital: greater the risk greater is the requirement of capital and vice versa. Buz should be able to meet the max loss arising in the course, and avoid bankruptcy. Risk and Cost: Higher the risk higher would be the premium. higher the risk adjusted RoI, better is the reward to the investors
Risk Identification
Risks are contracted at transaction level- credit, operational but certain risks are managed at aggregate or portfolio level. Identify various risks and examine its impact o the portfolio and capital requirement. X Branch of Bank Y Ltd lent a loan of Rs.1 crore for 5 years at 1% over BPLR, BPLR being 10%. Loan repaid in quarterly instalments. Loan is funded by a 3 year deposit of Rs.1crore interest being 6%. Identify the risks.
Risk Measurement
Risk measures seeks to capture variations in earnings, market value, losses due to default etc (target variables). 3 categories: Sensitivity, Volatility, Downside Potential
Measuring volatility
Weekly volatility of stocks of X Ltd., based on historical observation
Week 1 2 3 4 5 Closing Price (Rs.) 20 25 22 30 32 Deviation from Mean Squared Deviation -5.8 -0.8 -3.8 4.2 6.2 33.64 0.64 14.44 17.64 38.44
129 Mean
Var
104.80
4.57
25.80
20.96 Volatility
Risk Pricing
Pricing should take into account the following: Cost of deployable funds Operating expenses Loss probabilities Capital charge Pricing is transaction based. This is the key reasons for risk measurement at transaction level.
Risk Mitigation
Credit risks- collateralisations, third party guarantees etc Interest rate risks- interest rate swaps, FRA or futures Forex risks- forwards, options and futures Through diversification also, mitigation of risks is possible.