Wednesday, 4 December 2019

Unit 12: Risk Management of Financial Derivatives


                 Unit 12: Risk Management of Financial Derivatives   

There are nine categories of risk for bank supervision purposes.
These risks are: strategic, reputation, price, foreign exchange, liquidity, interest rate, credit, transaction, and compliance.
Financial derivatives come in many shapes and forms, including futures, forwards, swaps, options, structured debt obligations and deposits, and various combinations thereof.
Risk containment measures include capital adequacy requirements of members, monitoring of member performance and track record, stringent margin requirements, position limits based on capital, online monitoring of member positions and automatic disablement from trading when limits are breached.
The objective of NSCCL—SPAN is to identify overall risk in a portfolio of all futures and options contracts for each member.

NSCCL has developed a comprehensive risk containment mechanism for the Futures & Options segment.
The most critical component of a risk containment mechanism is the online position monitoring and margining system.
The basis for any adjustment for corporate action shall be such that the value of the position of the market participants on cum and ex-date for corporate action shall continue to remain the same as far as possible.
Deep-out-of-the-money short options positions pose a special risk identification problem.
As they move towards expiration, they may not be significantly exposed to “normal” price moves in the underlying.
A calendar spread is a position in an underlying with one maturity which is hedged by an offsetting position in the same underlying with a different maturity.
Cross margining benefit is provided for offsetting positions at an individual client level in equity and equity derivatives segment.
Prior to the implementation of a cross margining mechanism positions in the equity and equity derivatives segment were been treated separately, despite being traded on the common underlying securities in both the segments.

Assignment margin: Assignment margin is levied in addition to initial margin and premium margin.
Derivative: A security, like an Option or Future, whose value is derived from another underlying security.
Futures contracts, forward contracts, and options are among the most common types of derivatives.
Financial derivatives: Financial derivatives are broadly defined as instruments that primarily derive their value from the performance of underlying interest or foreign exchange rates, equity, or commodity prices.
Premium margin: Premium margin is charged at client level.
Risk: The chance of financial loss, or more formally, the variability of returns associated with a given asset.
The chance that actual outcomes may differ from those expected.
Risk Array: The amount by which the futures and options contracts will gain or lose value over the look-ahead time under that risk scenario   Risk scenarios: The specific set of market conditions evaluated by SPAN, are called the risk scenarios.
SPAN risk parameter file: Risk arrays and other necessary data inputs for margin calculation are provided to members daily in a file called the SPAN risk parameter file.

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