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

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- the customer had specifically requested it;- it was known to the institution that the customer did so with fullinternal authority, being aware of the possibility that a loss couldbe concealed thereby; and- the relevant contracts will be marked to market so that thediscounted value of the contract and the loss arising from using theoff-market rate can be shown in the institution's accounts and itsreturns to the MA.C. CONFIRMATION PROCEDURES* The method of confirmation used should provide a documentationtrail that supports the institution's position in the event of disputes.* Outgoing confirmations should be initiated no later than one businessday after the transaction date. Any use of same-day telephoneconfirmations should be taped-recorded and followed with writtenconfirmations. Oral confirmation will be accepted only if the lines aretaped and agreed with counterparty in advance.* Outgoing confirmations should contain all relevant contract detailsand be delivered to a department independent of the trading unit ofthe counterparty. Follow-up confirmations should be sent if nocorresponding, incoming confirmation is received within a limitednumber of days after the contract is effected. The accounting/filingsystem should be able to identify booked contracts for which noincoming confirmations have been received. Records of outstandingunconfirmed transactions should be kept and reviewed by managementon a regular basis.* Incoming confirmations should be delivered to the designated personnelwho are responsible for reconciling confirmations with trading recordsand not to trading personnel.* All incoming confirmations should be verified with file copies of contracts/dealing slips and-for authenticity. All discrepancies should be promptlyidentified and investigated by an officer independent of the tradingGuideline on Risk Management of Derivatives and Other Traded Instruments
function for resolution. They should also be tracked, aged, and reportedto management. Trends by type should be identified and addressed.D. SETTLEMENT AND DISBURSEMENT PROCEDURES• Specific procedures should be established for the initiation of, andauthority for, fund transfer.• No one person in a fund transfer operation (e.g. SWIFT) should beresponsible for the processing, verifying and approving of a request.Only authorised persons with appropriate segregation of duties shouldhave access to fund transmission systems, cash books, accountinformation, and terminal facilities.• Reasons underlying requests for funds should be analysed anddocumented. Settlement staff should be alert to any unusualtransactions and immediately report them to management. They shoulddistinguish between payments made on behalf of the institution andthose on behalf of clients.* Institutions must determine the authenticity of fund transfer requestsbefore payments are released. This may include direct telephoneconfirmation with the counterparty in addition to the verification oftest keys.* In case test keys are used to verify the authenticity of requests fortransfer of funds, such test keys should be separated into two parts(fixed and variable) and reset with the counterparty on at least ayearly basis. Each part should be kept by a different staff. No test keyholders should be allowed to access the telex room.* Payments should be properly authorised prior to disbursement of funds.Dual approvals should be required for large payments to help ensurevalidity and correctness, whether released manually or via SWIFT, testedtelex or similar transmission systems. Access to the transmission systemshould be properly approved and granted on a need-to-perform basisand periodically reviewed by line management. In addition, adequateprocedures should be established to control password maintenance,Guideline on Risk Management of Derivatives and Other Traded InstrumentsMm
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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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price) of 9,000. For this transacti
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Page 122 and 123: ANDONOFINTRODUCTION1. The Monetary
Page 124 and 125: MANAGEMENT AND CORPORATE5. As the B
Page 126 and 127: ensure that there is sufficient awa
Page 128 and 129: 15. Branches of foreign banks which
Page 130 and 131: 20. Where the institution considers
Page 132 and 133: RISK MEASUREMENT25. Having identifi
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Page 136 and 137: 38. The measurement of the market r
Page 138 and 139: market, credit and liquidity risk o
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Page 142 and 143: 55. As noted earlier, the market or
Page 144 and 145: changes in portfolio value;d) the r
Page 146 and 147: 66. A basic and essential safeguard
Page 148 and 149: 73. It is essential that the intern
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
Page 156 and 157: Options risk should be captured; ri
Page 158 and 159: Annex D1. NOTIONAL OR VOLUME LIMITS
Page 160 and 161: assumptions on which they are based
Page 162 and 163: * There should be a unit independen
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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Derivatives in Plain Words by Frederic Lau, with a ... - HKU Libraries

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