By David Shirreff
Facing monetary threat is a transparent and colourful consultant to the peaks and crevasses of economic hazard administration, best during the conception and perform of danger taking from swaps and futures to credits derivatives and the consequences of Basel II, dynamic hedging, Monte Carlo simulations, chaos conception, neural networks, Raroc (risk-adjusted go back on capital), rigidity assessments, worst-case eventualities, and every kind of video games which are performed within the reason behind dealing with danger. moreover, it appears to be like at a few impressive disasters of possibility administration and the teachings that may be discovered from them.
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Extra info for Dealing With Financial Risk
The message conveyed by most of these sources is that derivatives and other leveraged products have been unfairly maligned. If their risks are understood, they can be useful tools. The implication is that the people behind the words you are reading – the coterie of risk-management professionals – know better. They have seen the pitfalls and so there is steady progress towards a better understanding of the way financial markets and institutions behave. With this new wisdom it is possible to make more money or to lose less.
Another loser was Gibson Greetings, which had signed several contracts with Bankers Trust that lost it $23m after the 1994 interest-rate rises. They included a libor squared contract in which Gibson received a fixed rate from Bankers Trust and paid out the square of the dollar libor rate in return, which was fine until rates started rising. Procter & Gamble, a detergent maker, also wrote several contracts with Bankers Trust that began to lose heavily when interest rates rose. In one case it ended up paying Bankers Trust over 14% above the normal commercial paper rate.
That was the prevailing climate. Regulators, somewhat blinded by science, were reaching the conclusion that they must learn to understand and then speak the same language. This was possibly their biggest mistake. But it began there, in 1996. It concerned the way regulators set banks’ regulatory capital: that is, the minimum amount of capital that banks should carry, given the size and riskiness of their assets. A commonsense cushion A rule of thumb has generally been 8%: if a bank has made $100m of loans, it needs $8m of capital to cushion it against the failure of some borrowers to repay.
Dealing With Financial Risk by David Shirreff