Investment Risk Management

Investment Risk Management Study Notes

• Analyzing financial instrument and portfolio risks is crucial before investment decisions
• It ensures alignment with customer's risk profile and desired risk/return
• Chapter aims to define risk types, analyze risk metrics, and explore risk reduction via diversification and derivatives

Types of Investment Risk

• Financial assets categorized into classes based on asset nature and predominant risk
• Equities class mainly exposes to equity price risk
• Interest rate product class concerns interest rate risk
• Credit product focuses on issuer risk
• Inflation risk, exchange rates, equity prices, and interest rate risk may be interconnected
• Identify risks associated with a financial instrument or portfolio and how they are interconnected is critical for efficient risk management

Market Risk

• Market risk is caused by fluctuations in variables like interest rates, exchange rates, equity prices, commodities, volatility etc.
• These variables, also called market risk factors, are impacted by financial and monetary conditions in tandem with player expectations
• Several risk types include; equity price risk, rate of interest risk, commodities price risk, volatility risk

Specific versus Systematic risk

• Portfolio theory categorizes market risk as systematic, which cannot be eliminated by diversification
• Specific risk is diversifiable
• Systematic risk affects the entire market or sector
• Sources include: economic downturn, natural disaster, civil unrest
• Specific risk, also called residual risk, is unique to an issuer
• It can stem from reduced sales or lawsuits
• This risk is reduced with diversification

Foreign exchange Risk

• Cash flows from foreign currency investments might devalue against consumption currency
• Exposure arises when assets are in different currencies than the reference currency
• Investor is exposed to risk that these currencies could depreciate
• Depreciation reduces asset value and future cash flows in reference currency

Inflation risk

• Saving delays consumption, requiring incentives to make up for lost consumption
• Remuneration, or premium, is required to match future cash flows with a general increase in the price of goods and services
• Sustained price increase leads to ‘inflation', measured by the consumer price index
• Inflation may be caused by expanded financial policy or inflated production costs, and exceeding global demand
• A rate of return is required to include inflationary expectations
  • Risk is based on increased inflation
  • Return may not be sufficient to compensate for the increase in prices

Credit Risk

• Issuer risk occurs when a financial instrument's issuer cannot meet financial obligations
• This involves paying interest or principal amounts
• Credit risk is inherent to debt securities
• Holders risk missed payments

Default Risk

• Default risk is an issuer's failure to pay according to schedule
• Creditor rights impacting the debt recovery rate are a factor
• Default risk premium varies on debt ranking
• Credit analysis assesses payment ability; It's done by agencies providing scores
• Securities dealers, investors carry out credit analysis
• Issuer risk from elevated default risks impacts equity price risk
• Negatively impacts equities, particularly ordinary shares, given shareholders' lower priority than creditors
• Deterioration in credit quality increases the default risks
• Investors demand a premium for greater debt instrument yield
• Issuer risk is reduced by portfolio diversification

Settlement Risk

• Settlement risk exposure occurs when investors undertake transactions
• Occurs when a counterparty fails to pay or deliver securities on the specified date
• Buyer risks paying without receiving securities, and vice versa
• Delivery-versus-payment (DVP) manages the risk
• Securities are delivered only when relevant accounts are debited and/or credited
• DVP infrastructure exists in most countries on the organized and OTC markets

Counterparty Risk

• Counterparty risk arises when the counterparty defaults in contractual commitments
• E.g., bank defaults with customer cash deposits
• In derivative products, customer risks counterparty not fulfilling transaction obligations when contract expires or becoming insolvent
• Managed market risk via margin deposits, clearing house as central counterparty (CCP)

Liquidity Risk

• Liquidity exists when entities quickly buy or sell securities without impacting price
• Indicators estimating are: the number of instruments exchanged and bid-ask spread

Country Risk

• Country risk involves political/regulatory/legal framework impacts to an investment's value, including:
• Country confiscating assets; Investor inability to repatriate capital due to unrest
• Accounting transparency that could impact the assessment of credit quality
• Legal systems could be less beneficial for shareholders; Possible inconsistent enforcement of laws
• Financial and economic risks that negatively impact business.

Quantitative Risk Measurement Indicators

Volatility

• Measures the risk tied to portfolio of financial assets/instrument
• Reflects spread of price and/or return
• Market participants consider an asset as increasingly risky, when there’s greater volatility

Standard Deviation

• Measure of volatility is determined using standard deviation
• Represents how dispersed a data set is in relation to the mean; lower standard deviation means the more closely that the values cluster around the mean

Annualized Standard deviation

• Calculates standard deviation from annual returns
• Calculated with quarterly, weekly or daily returns
• Annualized standard deviations are widely used to weigh the volatility of instruments that may be calculated over different periods
• σannualized = σcalculated x √k
• k is the number of calculated periods per year

Volatility and Normal Distribution

• Distribution of returns can be depicted graphically
• 'Normal' distribution of returns generally are demonstrated in a bell-shaped curve
• Greater standard deviation equates to greater spread and curve is flatter

Understanding Beta

• The capital asset pricing model provides a calculation method for expected return on assets, based on financial risk that has been calculated by beta
• equation: E(Ri) = Rf + βi×[E(RM) – Rf].
• E(Ri) = expected return of asset i.
• Rf = risk-free interest rate
• [E(RM) – Rf ] = difference between the market’s expected return E(RM) and the risk-free interest rate, known as the ‘market risk premium'.
• 𝛽i = beta of asset i, which is Cov (Ri;RM) / Var(RM)

Estimating and Interpreting Beta

• The Financial asset’s beta(βi) can assess risk weighed against an index that is a benchmark/market sector
• Beta formula: βi = Cov (Ri ; RM) / Var (RM)
• Following must be done in practice:
• Find Benchmark Index returns along asset returns covariance within set period of time
• Excel is useful
• Assess variance of the benchmark’s return over set time frame
• Excel is useful
• Divide the product of First with 2nd Step

Risk Reduction And Diversification

• Diversifying a portfolio means savings spread over different instruments/assets- not 'all eggs in same basket’
• Allows for portfolio risk reduction without impacting return
• Financial assets will not move together similarly in the same conditions
• Reduced volatility via portfolio diversification

Correlation Coefficient

• Expressed as P
• Represents degree of two assets returns in relation to similar market circumstances and their tendency to develop the same
• Each asset has correlation coefficient
• Assets, A, B, and C create correlations; ρAB, ρAC and ρBC must all be evaluated
• The values are between +1 and -1
• Positive coefficient =positive return equals other asset positive return
• Values more closely tied to +1.0 = asset move more together in finance which deems them 'highly positively correlated'
• 1.0 correlation coefficient = linear at the same time.
• Negative correlation coefficient = return is accompanied in opposites
• -1.0 means more closely together with return
• In this finance space, returns are 'highly negatively correlated'

Portfolio Risk And Diversification

• Total portfolio risk may be lowered without needed impact to expect return via diversification
• The variance of a two asset portfolio (A and B): σP2 = wA2σA2 + wB2σB2 + 2wAw BσAσBρAB
• Assets with +1 of perfect positive correlation.
• Diversification does not bring reduction of risk
• The two assets with less correlated positives brings risk reduction.
• Two un-correlated or zero coefficient assets brings risk reduction on portfolio. Negative correlation = reducing portfolio risk with loss of anticipated return
• -1 on correlation yields greatest impact
• Reducing is possible thanks to correlated assets or the standard variant is almost identical, or weighing within portfolio

Efficient versus Naive Diversification

• Naive diversification comes when assets are designated at random
• The investment portfolios decline, as measured by deviations
• Marginal decline is limited past a certain number
• Once portfolio goes beyond approximately 30 investments- system risk remains
• Costs from transaction monitoring are greater on this level
• Not optimal to carry instruments
• 'Efficient diversification- Markowitz
• Determine composition that maximizes profit with lower risk for the portfolio/ the process of 'Portfolio Optimisation'
• Risk increases and the portfolios are deemed efficient on the 'efficient Frontier'
• Investors select portfolio aligned with their comfort from this frontier
• This is marketing that is very important for different firms looking for collective organization Most efficient frontiers depend on a risk and return from class more over an individual investment
• To make sure there is sufficient distribution within this class, investors have individual investments
  • For example stocks

Risk Management via Derivative Products

• Even with decent portfolio reduction there should be more active management done
• Derivative instruments is 'insurance' that can decrease risks for short/long periods
• Chapter has examples of such to handle derivatives and the risk of portfolios

Understanding Derivative Products

• This is a financial instrument between two parties stating the upcoming transaction
• It could be firm or optional on events taking place
• Economic clauses talk about what is underlying such as; shares, commodity etc., pricing date, settlement date
• Clauses note how transacting is done; physically or in cash
• Physical settlement- number of underlying at asset rate * quantity
• Cash Settlement is paying differences
• It is called derivatives as their value aligns with what is underlying them
• Economic derivatives transfer risk such as meteorology and credit

Use of Derivatives

Participants use derivative contracts to hedge exposure to risks or even to gain exposure Concluding derivative contracts exposes participants to counterparty risk This risk may be managed by providing collateral or creating a clearing house Customers deposit two types of margin: initial and variation The initial margin covers liquidation losses, while variation margin ensures the nondefaulting party covers losses by concluding another contract Contract for difference is the unrealized profit or loss Guarentee fund does not make a fall to hedge

Derivatives : Classifications

• Include swaps, options, futures, forwards

Key Facts About Futures

• Agreement for future transaction- firm transaction and must carry out contract
• The parties must buy underlying in line with contract
• Exchanges dictate legal/economic components
• Number of contracts is the only thing that is negotiable
• They are via contractual agreement- each contract has share number
• The financial assets that are used often are; equities indexes etc.
• Futures positions reduced by trading another listing

Key facts About Forwards

• Forward transaction=agreement
• OTC markets and non-standardized is the differential to futures
• Positions reduced by cancellation

Understanding Options

• Contract whose terms create an options transaction that will occur
• Either calls or puts
• Buyer of call option obtains the right to buy a pre-set amount of underlying assets in return for some premium
• If strike price is met- seller (call) is liable
• Buyer for 'put' has sell right
• It met then seller MUST act Terms:
• In the money: Option is one that holds the current money if it is used
• At the money: price is equal to the market price at strike.
• Exeercising is bad compared to if the asset was carried out directly in that particular market

Swaps

• Swaps help to have future transactions in certain scenarios
• financial flows- based via value on agreed contract

Index Futures And Management

• Risk management reduces through futures through hedging
• To do this
• Position may see decline: theory is to sell underlying to hedge
  • Objective should be covering loss when underlying price declines
• Position improves: theory is buy the future if financial commitment
  • Objective to benefit and hedge loss
• Hedging is optimal when it decreases all risk/ hedging offers assurance on price
• Final phase= contracts
• An index future is a deal where entities firmly make commitment on transaction over index As not possible to physically list an index - settlement is done through financial payment/ cash Each index point needs a financial amount for value and function of points
• The value on set payment date= the 'settlement price;

Example

Let us assume that on 7 May, customer Dupont sold one index futures contract XYZ at a price of 1,250 points. The contract expires on 30 June and the value of one index point is USD 10 The customer’s exposure to index XYZ can therefore be expressed as a monetary value at USD 12,500 (= 1,250 × USD 10 × 1). Since customer Dupont has a short position in the contract, the customer will make a gain if the index XYZ falls Supposing customer Dupont holds the contract to expiration, the cash flow on the contract will be: The value on the flow= settlement Price Price future and negotiated= index value to transpire future

Calculating Contract Numbers

• E(RP) = Rf + βP×[E(RM) – Rf]
• Future number must reflect beta
• In an Equity position- hedge index

Contract Number: =Value of holdings which need to be leveraged ÷ (Number of points × every index payment count)

Basis Risk

If investor doesn't match with future the hedging is imperfect Examples:

• Underlying asset doesn't align with future asset
• Expiry doesnt equal period investor needs
• Beta changes
• Impossible tradable number

Options And Risk Management

Buying Puts

• Put options act to protect the assets
• In order it to work;
• Buy to get premium- this buys right to sell the underlying asset for expiration period or prior
• underlying value is more than the price at strike= investors may not act
  • Profit may exist
• Underlying is less - investors will want to action and profit at higher value than what is listed

Systematic Risk

• most traded in European cash and is a index fund Monetary Value:
• define indexes that are closely in portfolio
• Get asset values by first identifying and deciding how to hedge. The value is in relationship to all those needs to be leveraged, and it divides market levels by the price at per Index

Hedging with a Collar

• Strategy performed at same time
  • Buy puts
  • Sell Calls
• Financing puts to collect premiums
• Seeks for almost zero dollar cover

Contracts For Difference

Is financial contract involving both a buyer and seller and they both establish transactions which will come later

Price difference is recorded the time the contract was made vs when it is called or ceases

Using Contracts

• The Principle is a short spot or CFD
• Short Spot = Sell CFD To attain this, the shareholder needs fall prices otherwise a gaim is needed This would benefit customer on that asset position

Structured Products

• Issuers are in agreement on a scheduled, they can honour Debt Products:

Issued for structure/ debt instruments are therefore acknowledgements of debt

Structure Of Debt

• Zero coupon as structured products with derivaties

Capital Protected vs Structured Protection

• Structure payment of product copy from potrfollio

• The product copies a scheduled

• Deposity to secure funds for the capital

Guarantees

There is an available call from security which investor is supposed to rise upon an under lying -There is a putting security -The putting ensures a fall from the product

How to Increase Security

• Product of the scheduled for protection has to be equal to number shown in each settlement

• Protection as it decreases, then expected return goes high

• Amount in the debt must be smaller

• Return rates is what is important as market returns dont get protection

• To have a capital you must act upon issue of product if there is default or other liability

Derivatives and Hedging

• Derivative act an insurance for risk reduction and eliminate some threats
• Short long periods: derivative can help this

CAPM : Investors can get risk

If the asset can eliminate all the portfolio is can be diversifibale risk or market Marketable : the one that can diversify investor

The Investors will reduce diversification

• Delivery, portfolio means can not be corrected = performance

• These portfolio means cannot be collected/ diversified

Strategy is is required for low volatility exposure then changes

• Diversified instruments means for high volatility exposure then changes
• There can be derivative products used to reduce portfolio based instruments
• Chapter illustrates with instruments

Investment Risk Management Study Notes

• Analyzing financial instrument and portfolio risks is crucial before investment decisions
• It ensures alignment with customer's risk profile and desired risk/return
• Chapter aims to define risk types, analyze risk metrics, and explore risk reduction via diversification and derivatives

Types of Investment Risk

• Financial assets categorized into classes based on asset nature and predominant risk
• Equities class mainly exposes to equity price risk
• Interest rate product class concerns interest rate risk
• Credit product focuses on issuer risk
• Inflation risk, exchange rates, equity prices, and interest rate risk may be interconnected
• Identify risks associated with a financial instrument or portfolio and how they are interconnected is critical for efficient risk management

Market Risk

• Market risk is caused by fluctuations in variables like interest rates, exchange rates, equity prices, commodities, volatility etc.
• These variables, also called market risk factors, are impacted by financial and monetary conditions in tandem with player expectations
• Several risk types include; equity price risk, rate of interest risk, commodities price risk, volatility risk

Specific versus Systematic risk

• Portfolio theory categorizes market risk as systematic, which cannot be eliminated by diversification
• Specific risk is diversifiable
• Systematic risk affects the entire market or sector
• Sources include: economic downturn, natural disaster, civil unrest
• Specific risk, also called residual risk, is unique to an issuer
• It can stem from reduced sales or lawsuits
• This risk is reduced with diversification

Foreign exchange Risk

• Cash flows from foreign currency investments might devalue against consumption currency
• Exposure arises when assets are in different currencies than the reference currency
• Investor is exposed to risk that these currencies could depreciate
• Depreciation reduces asset value and future cash flows in reference currency

Inflation risk

• Saving delays consumption, requiring incentives to make up for lost consumption
• Remuneration, or premium, is required to match future cash flows with a general increase in the price of goods and services
• Sustained price increase leads to ‘inflation', measured by the consumer price index
• Inflation may be caused by expanded financial policy or inflated production costs, and exceeding global demand
• A rate of return is required to include inflationary expectations
  • Risk is based on increased inflation
  • Return may not be sufficient to compensate for the increase in prices

Credit Risk

• Issuer risk occurs when a financial instrument's issuer cannot meet financial obligations
• This involves paying interest or principal amounts
• Credit risk is inherent to debt securities
• Holders risk missed payments

Default Risk

• Default risk is an issuer's failure to pay according to schedule
• Creditor rights impacting the debt recovery rate are a factor
• Default risk premium varies on debt ranking
• Credit analysis assesses payment ability; It's done by agencies providing scores
• Securities dealers, investors carry out credit analysis
• Issuer risk from elevated default risks impacts equity price risk
• Negatively impacts equities, particularly ordinary shares, given shareholders' lower priority than creditors
• Deterioration in credit quality increases the default risks
• Investors demand a premium for greater debt instrument yield
• Issuer risk is reduced by portfolio diversification

Settlement Risk

• Settlement risk exposure occurs when investors undertake transactions
• Occurs when a counterparty fails to pay or deliver securities on the specified date
• Buyer risks paying without receiving securities, and vice versa
• Delivery-versus-payment (DVP) manages the risk
• Securities are delivered only when relevant accounts are debited and/or credited
• DVP infrastructure exists in most countries on the organized and OTC markets

Counterparty Risk

• Counterparty risk arises when the counterparty defaults in contractual commitments
• E.g., bank defaults with customer cash deposits
• In derivative products, customer risks counterparty not fulfilling transaction obligations when contract expires or becoming insolvent
• Managed market risk via margin deposits, clearing house as central counterparty (CCP)

Liquidity Risk

• Liquidity exists when entities quickly buy or sell securities without impacting price
• Indicators estimating are: the number of instruments exchanged and bid-ask spread

Country Risk

• Country risk involves political/regulatory/legal framework impacts to an investment's value, including:
• Country confiscating assets; Investor inability to repatriate capital due to unrest
• Accounting transparency that could impact the assessment of credit quality
• Legal systems could be less beneficial for shareholders; Possible inconsistent enforcement of laws
• Financial and economic risks that negatively impact business.

Quantitative Risk Measurement Indicators

Volatility

• Measures the risk tied to portfolio of financial assets/instrument
• Reflects spread of price and/or return
• Market participants consider an asset as increasingly risky, when there’s greater volatility

Standard Deviation

• Measure of volatility is determined using standard deviation
• Represents how dispersed a data set is in relation to the mean; lower standard deviation means the more closely that the values cluster around the mean

Annualized Standard deviation

• Calculates standard deviation from annual returns
• Calculated with quarterly, weekly or daily returns
• Annualized standard deviations are widely used to weigh the volatility of instruments that may be calculated over different periods
• σannualized = σcalculated x √k
• k is the number of calculated periods per year

Volatility and Normal Distribution

• Distribution of returns can be depicted graphically
• 'Normal' distribution of returns generally are demonstrated in a bell-shaped curve
• Greater standard deviation equates to greater spread and curve is flatter

Understanding Beta

• The capital asset pricing model provides a calculation method for expected return on assets, based on financial risk that has been calculated by beta
• equation: E(Ri) = Rf + βi×[E(RM) – Rf].
• E(Ri) = expected return of asset i.
• Rf = risk-free interest rate
• [E(RM) – Rf ] = difference between the market’s expected return E(RM) and the risk-free interest rate, known as the ‘market risk premium'.
• 𝛽i = beta of asset i, which is Cov (Ri;RM) / Var(RM)

Estimating and Interpreting Beta

• The Financial asset’s beta(βi) can assess risk weighed against an index that is a benchmark/market sector
• Beta formula: βi = Cov (Ri ; RM) / Var (RM)
• Following must be done in practice:
• Find Benchmark Index returns along asset returns covariance within set period of time
• Excel is useful
• Assess variance of the benchmark’s return over set time frame
• Excel is useful
• Divide the product of First with 2nd Step

Risk Reduction And Diversification

• Diversifying a portfolio means savings spread over different instruments/assets- not 'all eggs in same basket’
• Allows for portfolio risk reduction without impacting return
• Financial assets will not move together similarly in the same conditions
• Reduced volatility via portfolio diversification

Correlation Coefficient

• Expressed as P
• Represents degree of two assets returns in relation to similar market circumstances and their tendency to develop the same
• Each asset has correlation coefficient
• Assets, A, B, and C create correlations; ρAB, ρAC and ρBC must all be evaluated
• The values are between +1 and -1
• Positive coefficient =positive return equals other asset positive return
• Values more closely tied to +1.0 = asset move more together in finance which deems them 'highly positively correlated'
• 1.0 correlation coefficient = linear at the same time.
• Negative correlation coefficient = return is accompanied in opposites
• -1.0 means more closely together with return
• In this finance space, returns are 'highly negatively correlated'

Portfolio Risk And Diversification

• Total portfolio risk may be lowered without needed impact to expect return via diversification
• The variance of a two asset portfolio (A and B): σP2 = wA2σA2 + wB2σB2 + 2wAw BσAσBρAB
• Assets with +1 of perfect positive correlation.
• Diversification does not bring reduction of risk
• The two assets with less correlated positives brings risk reduction.
• Two un-correlated or zero coefficient assets brings risk reduction on portfolio. Negative correlation = reducing portfolio risk with loss of anticipated return
• -1 on correlation yields greatest impact
• Reducing is possible thanks to correlated assets or the standard variant is almost identical, or weighing within portfolio

Efficient versus Naive Diversification

• Naive diversification comes when assets are designated at random
• The investment portfolios decline, as measured by deviations
• Marginal decline is limited past a certain number
• Once portfolio goes beyond approximately 30 investments- system risk remains
• Costs from transaction monitoring are greater on this level
• Not optimal to carry instruments
• 'Efficient diversification- Markowitz
• Determine composition that maximizes profit with lower risk for the portfolio/ the process of 'Portfolio Optimisation'
• Risk increases and the portfolios are deemed efficient on the 'efficient Frontier'
• Investors select portfolio aligned with their comfort from this frontier
• This is marketing that is very important for different firms looking for collective organization Most efficient frontiers depend on a risk and return from class more over an individual investment
• To make sure there is sufficient distribution within this class, investors have individual investments
  • For example stocks

Risk Management via Derivative Products

• Even with decent portfolio reduction there should be more active management done
• Derivative instruments is 'insurance' that can decrease risks for short/long periods
• Chapter has examples of such to handle derivatives and the risk of portfolios

Understanding Derivative Products

• This is a financial instrument between two parties stating the upcoming transaction
• It could be firm or optional on events taking place
• Economic clauses talk about what is underlying such as; shares, commodity etc., pricing date, settlement date
• Clauses note how transacting is done; physically or in cash
• Physical settlement- number of underlying at asset rate * quantity
• Cash Settlement is paying differences
• It is called derivatives as their value aligns with what is underlying them
• Economic derivatives transfer risk such as meteorology and credit

Use of Derivatives

Participants use derivative contracts to hedge exposure to risks or even to gain exposure Concluding derivative contracts exposes participants to counterparty risk This risk may be managed by providing collateral or creating a clearing house Customers deposit two types of margin: initial and variation The initial margin covers liquidation losses, while variation margin ensures the nondefaulting party covers losses by concluding another contract Contract for difference is the unrealized profit or loss Guarentee fund does not make a fall to hedge

Derivatives : Classifications

• Include swaps, options, futures, forwards

Key Facts About Futures

• Agreement for future transaction- firm transaction and must carry out contract
• The parties must buy underlying in line with contract
• Exchanges dictate legal/economic components
• Number of contracts is the only thing that is negotiable
• They are via contractual agreement- each contract has share number
• The financial assets that are used often are; equities indexes etc.
• Futures positions reduced by trading another listing

Key facts About Forwards

• Forward transaction=agreement
• OTC markets and non-standardized is the differential to futures
• Positions reduced by cancellation

Understanding Options

• Contract whose terms create an options transaction that will occur
• Either calls or puts
• Buyer of call option obtains the right to buy a pre-set amount of underlying assets in return for some premium
• If strike price is met- seller (call) is liable
• Buyer for 'put' has sell right
• It met then seller MUST act Terms:
• In the money: Option is one that holds the current money if it is used
• At the money: price is equal to the market price at strike.
• Exeercising is bad compared to if the asset was carried out directly in that particular market

Swaps

• Swaps help to have future transactions in certain scenarios
• financial flows- based via value on agreed contract

Index Futures And Management

• Risk management reduces through futures through hedging
• To do this
• Position may see decline: theory is to sell underlying to hedge
  • Objective should be covering loss when underlying price declines
• Position improves: theory is buy the future if financial commitment
  • Objective to benefit and hedge loss
• Hedging is optimal when it decreases all risk/ hedging offers assurance on price
• Final phase= contracts
• An index future is a deal where entities firmly make commitment on transaction over index As not possible to physically list an index - settlement is done through financial payment/ cash Each index point needs a financial amount for value and function of points
• The value on set payment date= the 'settlement price;

Example

Let us assume that on 7 May, customer Dupont sold one index futures contract XYZ at a price of 1,250 points. The contract expires on 30 June and the value of one index point is USD 10 The customer’s exposure to index XYZ can therefore be expressed as a monetary value at USD 12,500 (= 1,250 × USD 10 × 1). Since customer Dupont has a short position in the contract, the customer will make a gain if the index XYZ falls Supposing customer Dupont holds the contract to expiration, the cash flow on the contract will be: The value on the flow= settlement Price Price future and negotiated= index value to transpire future

Calculating Contract Numbers

• E(RP) = Rf + βP×[E(RM) – Rf]
• Future number must reflect beta
• In an Equity position- hedge index

Contract Number: =Value of holdings which need to be leveraged ÷ (Number of points × every index payment count)

Basis Risk

If investor doesn't match with future the hedging is imperfect Examples:

• Underlying asset doesn't align with future asset
• Expiry doesnt equal period investor needs
• Beta changes
• Impossible tradable number

Options And Risk Management

Buying Puts

• Put options act to protect the assets
• In order it to work;
• Buy to get premium- this buys right to sell the underlying asset for expiration period or prior
• underlying value is more than the price at strike= investors may not act
  • Profit may exist
• Underlying is less - investors will want to action and profit at higher value than what is listed

Systematic Risk

• most traded in European cash and is a index fund Monetary Value:
• define indexes that are closely in portfolio
• Get asset values by first identifying and deciding how to hedge. The value is in relationship to all those needs to be leveraged, and it divides market levels by the price at per Index

Hedging with a Collar

• Strategy performed at same time
  • Buy puts
  • Sell Calls
• Financing puts to collect premiums
• Seeks for almost zero dollar cover

Contracts For Difference

Is financial contract involving both a buyer and seller and they both establish transactions which will come later

Price difference is recorded the time the contract was made vs when it is called or ceases

Using Contracts

• The Principle is a short spot or CFD
• Short Spot = Sell CFD To attain this, the shareholder needs fall prices otherwise a gaim is needed This would benefit customer on that asset position

Structured Products

• Issuers are in agreement on a scheduled, they can honour Debt Products:

Issued for structure/ debt instruments are therefore acknowledgements of debt

Structure Of Debt

• Zero coupon as structured products with derivaties

Capital Protected vs Structured Protection

• Structure payment of product copy from potrfollio

• The product copies a scheduled

• Deposity to secure funds for the capital

Guarantees

There is an available call from security which investor is supposed to rise upon an under lying -There is a putting security -The putting ensures a fall from the product

How to Increase Security

• Product of the scheduled for protection has to be equal to number shown in each settlement

• Protection as it decreases, then expected return goes high

• Amount in the debt must be smaller

• Return rates is what is important as market returns dont get protection

• To have a capital you must act upon issue of product if there is default or other liability

Derivatives and Hedging

• Derivative act an insurance for risk reduction and eliminate some threats
• Short long periods: derivative can help this

CAPM : Investors can get risk

If the asset can eliminate all the portfolio is can be diversifibale risk or market Marketable : the one that can diversify investor

The Investors will reduce diversification

• Delivery, portfolio means can not be corrected = performance

• These portfolio means cannot be collected/ diversified

Strategy is is required for low volatility exposure then changes

• Diversified instruments means for high volatility exposure then changes

• There can be derivative products used to reduce portfolio based instruments

• Chapter illustrates with instruments

• struments