Derivatives in Plain Words by Frederic Lau, with a ... - HKU Libraries

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* There should be a unit independent of the trading room responsiblefor reviewing daily reports to detect excesses in approved trading andcredit limits.B. TRADE ENTRY AND TRANSACTION DOCUMENTATION* Management should ensure that procedures are in place to provide aclear and fully documented audit trail of derivatives transactions. Theseprocedures should be adequate to inform management of tradingactivities and to facilitate detection of non-compliance with policiesand procedures. The information on derivatives transactions shouldbe in a format that can be readily reviewed by the institution'smanagement as well as by internal and external auditors.* There should be sufficient accounting and other records that captureand record on a timely basis and in an orderly fashion every transactionwhich the institution enters into to explain:- its nature and purpose (e.g. trading or hedging);- any asset and/or liability, actual and contingent, which respectivelyarises or may arise from it; and- any income and/or expenditure, current and/or deferred, whicharises from it.* All derivatives transactions should be sequentially controlled (e.g. theuse of prenumbered dealing slips), timed and tracked by tape recordingof dealers 1 telephones to ensure that all deals are accounted for andto provide an audit trail for deals effected.Sequence of theprenumbered forms should be reviewed and accounted for periodically.Tape recording equipment should not be accessible by the dealers andshould remain under the control of management.* To establish valid contracts, records of original entries should capturesufficient details, including:- Time and date of execution.- Name of dealer executing transactions.- Name of staff entering transaction data (if different from dealer).IBSGuideline on Risk Management of Derivatives and Other Traded Instruments
- Name of counterparty.- Type of instrument, price, and amount.- Settlement or effective date.- Payment or settlement instructions.- Brokers 1 fees or commissions and other expenses.• Dealers should maintain a position sheet for each product traded andcontinuous position reports in the dealing room. Dealers' positionreports should be submitted to management for review at the end ofeach trading day.• Daily position report should be prepared from the institution'sprocessing system/general ledger by back office personnel. The reportsshould include all transactions and be reconciled daily to the dealer'sposition reports.• Every transaction should be updated (i.e. mark to market) in thecalculation of market and credit risk limits.• There should be sufficient transaction documentation to support limitreporting and a proper audit trail. A unit independent of the frontoffice should be responsible for reviewing daily reports to detectexcesses of approved trading limits.• There should be an approved list of brokers, counterparties and explicitpolicies and procedures for dispute resolution.• Dealers should adhere to stated limits.If limit excesses arise,management approval should be obtained and documented prior toexecution of the transaction. There should be adequate records oflimit excesses.• Deals should be transacted at market rates. The use of off-marketrates as a base for the renewal of maturing derivatives contractsshould be on an exception basis and subject to the following conditions:- it is permitted in accordance with stated policies and proceduresof the institution and the justification and approval of suchtransactions are documented;Guideline on Risk Management of Derivatives and Other Traded Instruments
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THE UNIVERSITY OF HONG KONGLIBRARIE
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VI- . .7 « i8^p ! ««^^OOSHSlVCJ
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Ever since derivatives took centre-
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denominator, value at risk, which c
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the kind of information that superv
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This book is a team effort of the H
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While most market participants defi
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of this investment is 6.32 percent
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Mathematically, the relation betwee
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$10,000. (For simplification of pre
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Hong Kong does go up and the HSI ri
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3OF ATHEPRICING OF A FORWARD CONTRA
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COST OF CARRYIn the above example,
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interest rate swap rates. From thes
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Borrowers, on the other hand, usual
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Again we use our method of having t
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ates, the forward rate for the peri
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5In this chapter, we will discuss w
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often complain that there is too mu
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ABC also has three cash flows:1. It
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Assuming that there is no transacti
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simulation techniques and mathemati
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The calculation of credit risk proc
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The payments are exchanged every th
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the reference rate. When this type
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Effectively this is just a 2-year s
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This measure of duration is referre
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analysis, it also has its shortcomi
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Percentage change in price due to d
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8OFOptions are generally perceived
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OPTION'S PAYOFF PATTERNWhat about a
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Volatility is the most important fa
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fANDTrading options becomes more po
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You need to hold 7 shares of stock
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di = [ln(IOO/IOO) + (0.06 + O.P/2)
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is10In the previous chapter, we dis
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stock will go up in the near future
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If the stock price of A continues t
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OF AN11In the previous two chapters
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at-the-money option approaches its
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12Mortgage-backed securities (MBS)
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NEGATIVE CONVEXITYFor MBS, there is
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MULTI-CLASSIn 1983, Freddie Mac int
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13What is a hedge? According to the
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management to enter into swap and o
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transaction. For this criterion to
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CREDIT DEFAULT SWAPThe simplest for
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APPLICATION OF CREDIT DERIVATIVESYo
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in the US. Equally innovative, cred
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THE VARIANCE-COVARIANCE METHODThe t
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"cell" would have a cash flow expos
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Daily profit and loss ranked in asc
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of the market factor. Through this
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3. Most value at risk models use hi
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16ANDIn Chapter 5, we talked about
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Page 122 and 123: ANDONOFINTRODUCTION1. The Monetary
Page 124 and 125: MANAGEMENT AND CORPORATE5. As the B
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Page 132 and 133: RISK MEASUREMENT25. Having identifi
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Page 136 and 137: 38. The measurement of the market r
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Page 150 and 151: Market liquidity risk is the risk t
Page 152 and 153: Furthermore, contracts with the sam
Page 154 and 155: There are three main VAR approaches
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Page 158 and 159: Annex D1. NOTIONAL OR VOLUME LIMITS
Page 160 and 161: assumptions on which they are based
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Page 166 and 167: addition and deletion of operators,
Page 168 and 169: • Profits and losses resulting fr
Page 170 and 171: This book is due for return or rene
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