Please enable JavaScript.
Coggle requires JavaScript to display documents.
Market Risk (Identification and measurement of investment risk (Pearson…
Market Risk
-
Derivitives/ Shorting
Equity swaps
The advantage of this approach is that the cash flows are netted regularly so that the behaviour of the concentrated position is effectively exchanged for a more diversified position.
One disadvantage of the technique is that typically the stocks given into an equity swap cannot be voted on by the owner of the portfolio but such strictures can often be avoided by careful swap construction.
Using such a technique, the fund or investor agrees to give up the cash flows of the stock position and in return receive the cash flows of a diversified index or even the cash flows of a fixed income investment based for example on government bonds or a bond index.
The other significant risk in a swap is the counterparty risk introduced by the counterparty with which one sets up the swap. There is no central counterparty or intermediary exchange that may cover any losses
Options
Such products allow an investor to sell stocks at a fixed price until the option expires and this is a hedging strategy that protects the investor against the loss of value if the stock price should drop below a certain threshold.
The price of establishing an option position requires the payment of a premium much like an insurance policy.
There are also derivative strategies such as collars which use a combination of options. Such strategies can be structured in such a way that the value of the position is limited to a concentrated range.
Shorting
Short selling (also known as shorting or going short) is the practice of selling assets, usually securities, which have been borrowed from a third party with the intention of buying identical assets back at a later date to return to the lender
The short seller hopes to profit from a decline in the value of the assets between the sale and the repurchase, as he will pay less to buy the assets than he received on selling them.
Credit Default Swaps
Contracts which allow one party (the protection buyer) to buy protection from another party (the protection seller) in case a reference obligation from a legal entity defaults.
The protection buyer will pay a fee or premium either until maturity of the contract or until a default or other event occurs. If such an event occurs, then the protection buyer will receive compensation from the protection seller.
-
Correlation, Diversification & Optimisation
Correlation is a measure of how the movement of one instrument impacts another. Correlation, indicates the strength and direction of a linear relationship between two random variables. Correlation does not imply causation.
-
Optimisation - Taking advantage of occasional market mispricings by buying more of perceived well performing assets
Timely and accurate monitoring and feedback reporting will enhance the management of risk. This effectively completes the loop back into the policy to show the degree of success or lack of it and from which management decisions can rapidly be taken where an adjustment or improvement is required.