Transcript L2Apr2RiskMgmtDebacles

Risk Management
Framework,
Debacles &
An Options Review
Reasons exist for active
financial risk management
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SMOOTH EARNINGS!!!
Match Supply of Internally-generated
funds with Demand for funds for Capital
Expenditures
Match Employee’s incentives with
Investors
Match Information Advantage with
Transaction Ability & Cost of Transaction
Risk Programs
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Identification of risk sources
Evaluation of bearing risk vs. transfer,
and competitive response
Creation of financial positions to transfer
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Position description
Standardized vs. Proprietary positions
Pricing through arbitrage
Position maintenance and review
A Framework Example:
United Grain Growers
Core Businesses
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Primary: Grain Distributor
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Store, Sort and Transport
Board Grain: Wheat, Barley and Oats
w/ Floor Price
 Non-Board Grain: All Others w/ Variable Price
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Secondary: De-Facto Vertical Integration
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Crop Production Services (Spring)
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Farm Supplies (Fertilizer, Seed and Support)
Livestock Services (Feed)
Farm Business Communication (Extension)
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Biz Interruption
Cargo/Marine
Civil Disturb
Commodity
Competition
Consumer
Contracts
Credit
Counterparty
BofD/Officers
Data
Disease/Spoil
IT Failure
Employee Inj.
All Risks
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Employee Liab.
Employee Perf.
Environmental
FX
HQ Calamity
Indus. Spying
Intell. Property
Interest Rates
Inventory
Labor Strike
Leverage
Key Executive
M&A
Major Property
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Pension Liab.
Process Comp.
Product Liab.
Product Perf.
Political Risk
R&D
Regulatory
Stock Market
Strategy
Technology
Transportation
Unionization
Weather
Main Risks
Risk
Weather
Toxins
Counterparty
Credit
Inventory (Spoilage)
Commodity
Mgmt Technique
None
Insurance/Control
Diversify/Contracts
Diversify/Contracts
Oprtns/Insurance
Futures/Options
Debacles
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Gibson Greeting Cards 1993
Metallgesellschaft 1993
Proctor & Gamble 1993
Orange County 1994
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http://www.gsm.uci.edu/~jorion/oc/case.html
Barings Bank 1995
Long Term Capital Management 1998
A thorough listing
20 Biggest Trading Disasters
(http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/01/24/bcnsocgen324.xml)
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Societe Generale, Credit Suisse 2008
Basic Options Review
Options
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Right to Buy/Sell a specified asset at a
known price on or before a specified date.
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Call Option - Right to buy
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Put Option - Right to sell
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When Option Bought/Sold, Premium is
exchanged.
Option Specifications
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Current Price of Specified Asset - S
(S as we consider options on stocks first)
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Specified Price of Buy/Sell - X
(or Strike Price, so some use K)
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Last time to Buy/Sell – Expiry ( T )
(or Expiration date)
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Note: There will be other factors when we actually start
calculating prices, but for now we will take all market
prices as given.
Basic Option Payoffs: Call
Option
Price
Current
Stock
Price
Stock Payoffs
In
the Money
Payoff
Payoff
Out of
the Money
Price
Option
Exercise
Price
Call Option Payoffs
Call Option Payoff = Max[ 0 , S - X ]
(Intrinsic Value)
Basic Option Payoffs: Put Option
Price
Current
Stock
Price
Stock Payoffs
Out of
the Money
Payoff
Payoff
In
the Money
Price
Option
Exercise
Price
Put Option Payoffs
Put Option Payoff = Max[ 0 , X - S ]
(Intrinsic Value)