The purpose of this course is to give you a good and practical, “hands-on” understanding of strategies, tools and techniques for managing market risks.
We start with a general introduction to market risk and discuss how recent years’ dramatic developments in financial markets have lead to an increased urgency in managing risk generally. We review current best practices in market risk management, and we explain the process of identifying, measuring and managing market risk. We also introduce and explain the “general” quantitative techniques that are used in risk quantification.
We then turn to look in more detail at how the individual types of market risk are measured and managed. We explain and demonstrate how equity risk is measured at the single instrument and portfolio levels and how these risks can be mitigated using futures, options and swaps. Further, we explain how interest rate risk is measured using the duration concept, and we explain and demonstrate how general interest rate risk, yield curve risk and spread risk can be hedged using interest rate derivatives. We also explain and demonstrate how FX and commodity risk can be measured and managed.
After looking at the individual risk types, we introduce the important, aggregate risk measure “Value-at-Risk” (VaR). We explain how VaR is calculated for various risk types. We discuss the strengths and weaknesses of VaR and we point out the pitfalls of using VaR in isolation. We also explain how “stress testing” can and should be used to complement VaR measures.
Finally, we give you a thorough review of the regulatory treatment of market risk under the Basel rules. We explain and demonstrate how the “pillar 1” capital charges are calculated. We also explain how market risks are treated under “pillar 2”, and we discuss the internal and external reporting requirements.