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• W8485388 abstract "INTRODUCTION In a volatile world that revolves around economy and finance, governed by interest rate movements and profit and loss, we don't need to be reminded of how important effective risk management is to financial institutions in twenty first century. This is particularly true since advent of IASC 39 (International Accounting Standards Committee), who have introduced new regulations regarding treatment of and how to prove its effectiveness. Managing exposure inherent in balance sheet and against dramatic loss are two of most valuable lessons to learn. Although is an integral part of risk management, there is also more to it than meets eye: To look deeper into we need to look at what exactly is, how it can be optimised and is it a good idea? WHAT IS HEDGING? In basic terms, is the taking of a position, acquiring either a cash flow, an asset, or a contract that will rise or fall in value to offset a fall or rise in value of existing position. (Multi- National Business Finance. K. David, A. Eitemann & M. Stonehill, Addison Wesley, 2001) For example, a forward rate agreement (FRA) is one instrument used to protect against loss in event of short term interest rates unpredictably rising. This is a pre-determined interest rate agreement aimed to reduce risk associated with adverse moves in rates. A more in depth analysis of FRAs will be described in detail later in article. By eliminating or at least reducing loss, also eliminates or reduces any gain that might be obtained from an increase in value of an existing asset should rates go down. This is one consideration in Risk vs Return debate investigated later. Historically banks have typically used MS Excel for simple methods, however we will see later an example of a third party solution's methods and advantages that follow. It is important to note that can be done on two levels: While macro is performed on a whole portfolio, micro is on an individual product level. The former is more commonly practiced. BUSINESS PROBLEMS Before we look at in any more detail, let us first turn to risks that are being addressed: Aside from foreign exchange risk, market risk, equity risk, credit risk, and liquidity risk, we want to focus on interest rate risk: If a bank has more rate-sensitive liabilities than assets, a rise in interest rates will reduce bank profits and a decline in interest rates will raise bank profits. The difference between these two is gap that banks can hedge to reduce risk. Rate movements can be brought on by all kinds of changes in market, including an oil crisis or warfare. So as we know, banks are concerned about their exposure to risk of earnings and returns that is associated with changes in interest rates. Due to often volatile rates in market, variance of risk without any form of is much greater (see figure.1). Greater gain if rates fall in your favour, but greater loss if they rise. Bringing us back to earlier point, which is a greater risk - to hedge or not to hedge? With obvious benefit of reducing risk, but possible disadvantage of restricting capital gain, how can we weigh up real value of hedging? METHODOLOGY Instruments Used For Hedging There are several key instruments, collectively known as derivatives, that are commonly used to hedge. These include: Forward rate agreements, (FRAs), interest rate futures, options and swaps. Not only can these instruments help reduce risk, but they can supplement profit generated by traditional banking methods. However, this is to be approached with caution as speculative hedging that generates income often cannot be counted as so on accounting books, since it is theoretical rather than real, depending on behaviour of rates. …" @default.
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• W8485388 date "2002-01-01" @default.
• W8485388 modified "2023-09-28" @default.
• W8485388 title "Balance Sheet Hedge Optimisation: Risk vs Return - to Hedge or Not to Hedge, That Is the Question?" @default.
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