instruments in interest-rate, currency and ... - Volksbank AG

RISK MANAGEMENTEvery company is forced to take risks whilst carrying out its business activities. The difference betweensuccess and failure often depends on correctly judging the risk involved in a single deal, transaction orbalance-sheet item – what risk can be taken, and to what extent? – and on the targeted risk managementbased upon this.The dynamic nature in which the world is developing is increasing the degree of uncertainty. Globalisationis creating new opportunities and risks. New technologies are accelerating business, whilst, however, alsoleading to ever quicker decision making and often to the radical transformation of organisational structuresand patterns of behaviour. The price of acquiring modern technology is often considerable, whilst itsworking life, on the other hand, is short due to the prevailing rapid speed of development. In addition,increasing concentrations of value and the dependency on highly developed and sensitive technical systemsincrease the company’s vulnerability. Strategic decisions and the results they lead to are therefore influencedby all kinds of risk. Such decisions force the management of companies to make decisions that were hithertothe domain of banks and insurers: those of methodical risk management.It is essential that the risk be identified on the one hand and then, inseparably related to this, quantified,in order to then be in a position to make the right decisions, realise business plans, and to evaluate theachieved results and secure the financial outcome for the company.The risks with which companies are confronted during day-to-day business are of a diverse nature.Sometimes it is at least possible to identify the risk, but then considerable problems are revealed duringthe quantification process. In the financial sector a methodology has existed for approximately a decade thathad previously proved successful for specialists, whereby risk can be quantified in a relatively simple manner.The development first started in 1994, when the controlling department of the international investmentbank, J.P. Morgan, began to summarise the bank’s total risk. It was used to bring interest rate risks, foreignexchange risks, stock risks and commodity risks down to a common denominator. The result was thesystem of “value at risk“. This concept lead to a single figure, which gave the investment bank’s controllingdivision information about how high the maximum loss from all positions per day would be with a certaindegree of probability.The concept of value at risk, which forms an estimate for the possible losses under normal marketconditions, has since developed into an internationally-used benchmark. The financial informationmentioned in the chapters on “Interest Rate Management” and “Currency Management” has pointed outa large selection of instruments that are required to control risk. The aim of this chapter is to explain riskanalysis and the quantification of risk, and to give indications about the associated risks for targetedmanagement of that risk.59