The purpose of this course is to give you a good and practical understanding of the risks encountered in derivatives transactions and of the methods and tools for managing these risks both on an individual and on an aggregate level.
We start by identifying and defining the major risk groups within derivatives and discuss how they inter-relate.
Subsequently we review and analyze the risk structure of key derivatives covering both exchange traded and OTC derivatives and we analyze how the risks differ from instrument to instrument.
We then look at how market risk in derivatives can be measured and managed. We identify and analyze the different types of market risk. We show how the market risk can be measured individually and on a portfolio level using Value-at-Risk and we discuss the mapping of a large portfolio to key risk factors.
Further, we look at how credit & counterparty risk can be measured using a simple add-on method and a more comprehensive "potential future exposure" method. We explain how counterparty risk can be effectively managed using active counterparty credit monitoring, counterparty position limits, margining and collateral. We explain and demonstrate how to measure and manage the "new" risk type, CVA risk, and we discuss how counterparty and CVA risk can be reduced or even eliminated by moving to CCP clearing of OTC derivates.
We continue by looking at liquidity risks of derivatives where key measures include open interest, volume and swap spreads. We discuss transactional liquidity risks of derivatives as well as liquidity shocks and so-called liquidity "Black Holes". We also explain how the liquidity impact of margin calls can be assessed, and we discuss the consequences for liquidity of the move to centralized clearing (CCP).
Finally we look at other risks involved in derivatives transactions with special emphasis on operational risk and legal & reputational risk.
Within operational risk we focus at the key challenge with derivative risk models and the robustness of mitigating techniques. We also give an overview of sound practices for managing operational risk.
Within legal & reputational risk we look at why the legal risks of derivatives are unique from traditional banking products. We explain how to associate costs with legal risks and show how legal & reputational risk can be modelled and used for limit setting. Finally, we discuss how to mitigate legal & reputational risk by fostering a "know your client" culture within the bank.
