y
Portfolio Management
¢ Portfolio Management — An Overview
¢ Portfolio Risk and Return — Part | ¢ Portfolio Risk and Return — Part II
¢ Basics of Portfolio Planning and Construction ¢ Risk Management — An Introduction
¢ Fintech in Investment Management
Trang 2: Los Define risk management
¢ What’s risk?
> Exposure to uncertainty
> Chance of loss or adverse outcome
¢ What’s risk management?
> Decisions taken to achieve maximum risk-adjusted return; >» The overall goal is to maximize firm value;
> Risk managers follow the “Doctrine of No Surprises”
Trang 3: Los Define risk management
Risk management can be institutionalized (enterprise-wide) or individualized (silo-based): Credit risk Enterprise risk management Inflation risk Interest rate risk
Silo-based: each risk is managed
Trang 5tosDescribe features of a risk management framework
Governance is the top-level system of structures and policies and risk governance ensures risk management activities align and support the overall
enterprise
It is often driven by regulatory concerns as well as the fiduciary role of the governing body
Trang 6LOS Describe features of a risk management framework
Risk identification and
measurement
¢ Environment is analyzed to identify the relevant risk factors ¢ Portfolio is analyzed to ascertain
whether it is indeed exposed to the risks identified
¢ Risk metrics are calculated to size these risks under various
Trang 7tosDescribe features of a risk management framework
TH €—— Risk Infrastructure
¢ Refers to people and
systems that carry out the risk management process e May include technology
solutions capable of capturing, storing,
computing and reporting the necessary data as well as skilled personnel to run this process
Trang 8tosDescribe features of a risk management framework
Policies and Processes
¢ Encompass day-to-day operation and decision- making processes
¢ May entail:
Trang 9tosDescribe features of a risk management framework
Risk Monitoring, Mitigation, and Management
¢ Entails continuous
assessment as to whether
the existing exposure is in
line with the established risk tolerance level
> If not, action must be
Trang 10tosDescribe features of a risk management framework
Communication/Reports
¢ Acommunication loop must be
put in place to ensure that: > Governance parameters can be clearly communicated to managers > Reporting of risk metrics to decision makers is done in a clear and timely manner
Reports must be written ina clear, easy to understand
Trang 11
tosDescribe features of a risk management framework
Strategic Analysis or Integration ¢ These help turn risk
management into an offensive weapon to improve
performance
Trang 12LosExplain how risk tolerance affects risk management
Risk tolerance identifies the extent to which the organization is prepared to experience losses or opportunity costs in the effort to achieve organizational objectives
¢ The risk tolerance decision requires the integration of internal
shortfalls in the organization which may cause failure as well as the external and sometimes uncertain risk drivers
¢ Determination of the risk tolerance level depends on: > The ability to respond dynamically to changing events;
> The ability to withstand losses and remain a going concern; > The competitive landscape; and
> The regulatory environment
¢ Personal motivations and beliefs, agendas of board members, and management compensation should not factor into the risk tolerance
Trang 13LosExplain how risk tolerance affects risk management
Risk budgeting is focused on implementing the risk tolerance
decisions taken at a strategic or governance level in the day-to-day management decision making
¢ The risk budget will quantify risk by specific metrics and allocate risk across the organization
¢ Arisk budget may:
> Use simple risk measures such as the standard deviation, VAR, Beta, and scenario loss
>» Use more complex risk measures such as evaluating risks by their underlying risk classes, such as equity, fixed income, commodity risk, and so on, and then allocates investments by their risk class
Trang 14LosExplain how risk tolerance affects risk management
Benefits of Risk Budgeting
¢ By implementing a risk budget, a risk culture is created in which all decisions are evaluated with a risk-return tradeoff in mind
Trang 15Losidentify financial and non-financial sources of risk and describe how they may interact
¢ Financial risks originate from financial markets They include: | Market risk: which arises from movements within the financial
market environment like share prices, interest rates, exchange rates, commodity prices and other economic or industry market factors
li Credit risk: the risk of loss due to the failure of one party to pay another an outstanding obligation
iti Liquidity risk: the inability to convert assets into cash without incurring significant costs
Trang 16Losidentify financial and non-financial sources of risk and describe how they may interact
Non-financial risks are from outside of the financial market
environment and could be as a result of environmental or regulatory changes or an issue with customers or suppliers
¢ They include:
I Settlement risk: arises when payments are not exchanged simultaneously
> The simplest case is when a bank makes a payment to a
counterparty but will not be recompensed until some time later; the risk is that the counterparty may default before making the
counterpayment
li Legal risk: risk of suits/ litigation
ili Compliance risk: failure to adhere to laid down rules/obligations iv Model risk: use of inappropriate models or inputs
Trang 17Losidentify financial and non-financial sources of risk and describe how they may interact
v Tail risk: the likelihood or probability of a material negative
outcome
vi Operational risk: related to the people and processes of an organization
> Examples: fraud on the part of employees/management, operational errors, and interruption due to natural
phenomena like floods and wild brazes
Trang 18Losidentify financial and non-financial sources of risk and describe how they may interact
Do financial risks and nonfinancial risks interact?
v The answer is yes
¢ In times of market stress, the correlation among financial and nonfinancial risks increases
¢ The result? The combined risk is often far more than the "sum-of-
the-parts." Example:
Suppose a key counterparty fails to settle an obligation in a timely manner Settlement risk creates a solvency risk for the company
which was due to receive the proceeds In turn, they may not be able to pay their suppliers which leads to legal risk Or, they may not meet
regulatory solvency requirements which creates compliance risk They may need to rapidly sell assets to raise the cash creating a
liquidity risk
Trang 19tosDescribe methods for measuring and modifying risk
exposures and factors to consider in choosing among the methods
Commonly used risk metrics are as follows: Standard deviation
¢ Standard deviation (also referred to as volatility) provides a measure of the range of potential outcomes
¢ It has limitations as a measure for financial markets as it presumes a normal distribution of returns which is inappropriate
Beta
¢ Beta is a measure of the sensitivity of a security’s returns to the overall market portfolio
¢ It provides an indication of systematic risk and is particularly appropriate for equity portfolios
Trang 20: tosDescribe methods for measuring and modiifying risk
exposures and factors to consider in choosing among the methods
Greeks (Delta, Gamma, Vega, Rho)
¢ Commonly referred to as "the Greeks", these metrics are appropriate for measuring the risk associated with derivative positions
> Delta measures the sensitivity to changes in the underlying price of the asset
> Gamma measures sensitivity to changes in the delta > Vega measures sensitivity to changes in volatility
> Rho measures sensitivity to changes in interest rates Duration
¢ Duration is a measure of sensitivity to interest rates used for fixed-
Trang 21tosDescribe methods for measuring and modifying risk
exposures and factors to consider in choosing among the methods
VaR (Value at Risk)
« VaR specifies the maximum loss that could possibly be incurred at a given level of confidence
¢ For instance, if the annual 95% VaR of a portfolio is $100 million, the firm is said to be 95% confident that the loss incurred, if any, will not exceed $100 million In other words, there is a 5% chance that if a loss is experienced over the next year, it will exceed $100 million Conditional VaR, CVaR
¢ Also called the expected shortfall, CVAR is the expected loss beyond the VAR
¢ It's analogous to the “loss given default.”
Trang 22tosDescribe methods for measuring and modifying risk
exposures and factors to consider in choosing among the methods Risk modification What options does a firm have on matters risk? 1) Risk avoidance > The firm effectively shelves investment plans or discontinues the existing exposure 2) Risk acceptance > The firm accepts a risk and proceeds to make an investment 3) Risk transfer > The firm accepts the risk but then transfers it to a third party, e.g , an insurer 4) Risk shifting
> The firm accepts and attempts to mitigate the risk, usually
through the use of derivatives
Trang 23y
Portfolio Management
Portfolio Management — An Overview Portfolio Risk and Return — Part |
Portfolio Risk and Return — Part II
Basics of Portfolio Planning and Construction Risk Management — An Introduction
> Fintech in Investment Management