An Introduction to Bond Markets, Fourth Edition

Chapter 14

RISK MANAGEMENT AND VALUE-AT-RISK

In this chapter we will consider aspects of the risks to which participants in the capital markets are exposed, and the risk management function to which banks and securities houses now devote a significant part of their resources. The profile of the risk management function and risk measurement tools such as Value-at-Risk was raised during the 1990s, following bank collapses such as that of Baring’s and other trading losses suffered by banks such as Daiwa and Sumitomo. It was widely rumoured that one of the driving forces behind the merger of the old UBS with Swiss Bank (in reality, a takeover of UBS by Swiss Bank; the merged entity was named UBS) was the discovery of a multi-million loss on UBS’s currency options trading book, which senior management had been unaware of right up until its discovery. In any case, shareholders of banks now demand greater comfort that senior executives are aware of the trading risks that their bank is exposed to, and that robust procedures exist to deal with these risks. For this reason it is now essential for all staff to be familiar with the risk management function in a bank.

CHARACTERISING RISK

The types of risk that a bank or securities house is exposed to as part of its operations in the bond and capital markets are broadly characterised as follows:

• Market risk - risk arising from movements in prices in financial markets. Examples include foreign exchange (FX) risk, interest-rate risk and ...