Risk Management Definition
Risk Management
2007-2008
Introduction
Risk management has to determine what risks exist in an investment and handle the risks in good investment objectives.
Risk management is very important in Finance. In this assignment, we will understand in a first part the basic measures of the risk management. Then we will have more interest of the implementation of the Value at Risk. In the environment of Hedge Fund, we have to develop the risk factors. And finally, in order to manage a trading book, we will describe the limit structure and the tools to use in order to measure the risk.
1. Describe the advantages and disadvantages for each of the following risk measures:
a. DV01
Definition: DV01, also called dollar value of a 1 basis point move, is a measure showing the dollar value of a one basis point decrease in interest rates.
It shows the change in a bond 's price compared to a decrease in the bond 's yield.
It is also the reference for the Basic Point Value, a method to measure interest rate risk.
Advantage Disadvantages
- It makes easier to calculate the BPV
DV01 = Initial Price – Price at 1BPV
- Permit to observe the higher risk level of future trade
- Easy to understand
- Thanks to the calculation of BPV and the correlation with DV01, we can:
- apply some approach to financial instrument (know the cash flow) ⇒ we can calculate BPV for money market products and swaps
- calculate simple hedge ratios - We don’t know how much the yield curve can move on a day-to-day basis with the BPV.
- With BPV, the yield can move up or down in a parallel manner, it’s not always the same.
b. Stress testing
Definition: A simulation technique used on asset and liability portfolios to determine their reactions to different financial situations.
Stress-testing is a useful method of determining how a portfolio will fare during a period of financial crisis.
A stress test is a scenario analysis relative to extreme change.
Advantage
2007-2008
Introduction
Risk management has to determine what risks exist in an investment and handle the risks in good investment objectives.
Risk management is very important in Finance. In this assignment, we will understand in a first part the basic measures of the risk management. Then we will have more interest of the implementation of the Value at Risk. In the environment of Hedge Fund, we have to develop the risk factors. And finally, in order to manage a trading book, we will describe the limit structure and the tools to use in order to measure the risk.
1. Describe the advantages and disadvantages for each of the following risk measures:
a. DV01
Definition: DV01, also called dollar value of a 1 basis point move, is a measure showing the dollar value of a one basis point decrease in interest rates.
It shows the change in a bond 's price compared to a decrease in the bond 's yield.
It is also the reference for the Basic Point Value, a method to measure interest rate risk.
Advantage Disadvantages
- It makes easier to calculate the BPV
DV01 = Initial Price – Price at 1BPV
- Permit to observe the higher risk level of future trade
- Easy to understand
- Thanks to the calculation of BPV and the correlation with DV01, we can:
- apply some approach to financial instrument (know the cash flow) ⇒ we can calculate BPV for money market products and swaps
- calculate simple hedge ratios - We don’t know how much the yield curve can move on a day-to-day basis with the BPV.
- With BPV, the yield can move up or down in a parallel manner, it’s not always the same.
b. Stress testing
Definition: A simulation technique used on asset and liability portfolios to determine their reactions to different financial situations.
Stress-testing is a useful method of determining how a portfolio will fare during a period of financial crisis.
A stress test is a scenario analysis relative to extreme change.
Advantage
Bibliography: www.wikipedia.org www.investopedia.com www.riskdata.com