Risk management : three cases

Résumé du document

Firm 1 is a large multinational organization with operations in several countries. The company's industry is currently experiencing an economic downturn. While the firm is currently in good shape, it wishes to avoid bad news as it is concerned about further economic downturns. The firm owns a variety of bonds in its investment portfolio and is thus not too worried about market risk. If the bonds were to decline in value due to credit events, the firm would experience losses it would rather avoid. What approaches or strategies could you recommend to mitigate this risk? Firm 2 is a large, regional bank. In the past, the bank mainly conducted business in its geographic region. The senior management recently decided to expand its business in other countries too. There are two general strategies driving this decision. First, the bank plans to expand the investment portfolio and buy sovereign bonds. These bonds are expected to be from emerging market countries and denominated in the currency of the issuer. Second, the bank will also extend loans to companies in other countries that may or may not be denominated in other currencies. The bank has traded foreign currency for its clients, but always on an agency basis. What would you recommend to mitigate the potential credit risk? Firm 3 is a large commercial bank. The bank has been experiencing high error rates in its processing of trades in bonds and currencies. This high failure rate is causing it to lose some clients due to the high cost of fixing errors. How would you go about assessing the situation and recommending improvements to the settlement process?

Extraits

[...] What approaches or strategies could you recommend to mitigate this risk ? In this case, we have to deal with credit risk. To mitigate this risk, we can use several tools that we will analyze just after. The first one that we can use is the credit derivative. In fact, a credit derivative is a contract which has the objective to transfer the risk to the total return of a credit and which arrives to a level from agreement, without transfer of the subjacent credit. [...]

[...] They generally know the market and all the secure transactions. They moreover can advise the company for the secure bonds, and the different countries in which they can buy sovereign bonds. Firm Firm 3 is a large commercial bank. The bank has been experiencing high error rates in its processing of trades in bonds and currencies. This high failure rate is causing it to lose some clients due to the high cost of fixing errors. How would you go about assessing the situation and recommending improvements to the settlement process? [...]

[...] Senior management recently decided to expand its business in other countries. There are two general strategies driving this decision. First, the bank plans to expand the investment portfolio and buy sovereign bonds. These bonds are expected to be from emerging market countries and denominated in the currency of the issuer. Second, the bank will also make loans to companies in other countries that may or may not be denominated in other currencies. The bank has traded foreign currency for its clients, but always on an agency basis. [...]

[...] The credit risk is made for one part by the Basel Committee II. According to the standardized Basel II approach, all the sovereign ratings used by rating agencies are expected to take an important part in the measurement of the credit risk. The quality of the sovereign ratings knows important problem and a lot of critics, particularly in emerging markets. In this case, we have to trade (buy sovereign bonds and make loans to company in other countries) with various actors in emerging markets countries. [...]

[...] In order to mitigate the risk and losses, and in this case the operational risk, several steps can be taken into account. For example, for damages due to natural disaster, we can buy an insurance against this. Losses coming from business disorder due to electrical failures for example can be mitigated by the set up of redundant backup facilities. Other kind of losses, the one due to internal reasons, like employee fraud or product defects, are very harder to identify, but we can be insured by the company itself, by strong internal auditing procedures for example. [...]