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AF
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CORPORATE TREASURY
RISK MANAGEMENT
YON VALTCHEV APRIL 2015
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TOPICS
Evolving Focus of Treasury - Risk Management
Breakdown of Financial Risks
Drivers of Financial Risks
Selecting Hedging Strategies
Portfolio Risk Management
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TREASURER’S EVOLVING ROLE
Pre-crisis focus
• Narrow operational and support focus on cash and liquidity
Post Financial Crisis Focus
• Focus on Risk Management and Strategic Planning
3
Funding
Cash & Liquidity
Interest Rate Risk
FX Risk
Commodity Risk
Credit Risk
Corporate Finance
Investor Relations
Insurance
Working Capital
Increased Responsibilities
Funding
Cash & Liquidity
Interest Rate Risk
FX Risk
Core Functions
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RISK BREAKDOWN
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RISK BREAKDOWN
5
Business Risk
Strategic Risk Financial Risk
Market Risk
Interest Rates
FX
Commodities
Credit Risk
Country
Industry
Issuer
Counterparty
Liquidity / Solvency
Funding
Liquidity
Operational Risk
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COMMON RISK MANAGEMENT CONCERNS
• Where does my exposure come from and how large it is?
• Am I sensitive to the changes of this exposure?
• Should I hedge?
• What are the available hedging strategies?
• At what level and how much should I be hedging?
• Should I be concerned about counterparty risk?
• What are the “Pros” and “Cons” of Clearing vs. paying-away CVA?
• Can I apply “Hedge Accounting” on my hedges?
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CREDIT & COUNTERPARTY RISK
7
Credit Exposure
Risk Measurement
Credit Ratings / Score Cards
Credit Spreads
Future Exposure (EPE/ENE)
Key Financial Ratio
Risk Mitigation
Collateralization / Third Party Guarantee
Diversification
Risk Based Pricing (CVA)
Covenants and Triggers
Credit Risk Hedging
Cleared Instruments
Netting Agreement
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DRIVERS OF FINANCIAL RISK
RATES & CREDIT CASE
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DRIVERS OF INTEREST RATE EXPOSURE 9
Swap curve underlying
instruments (ICVS)
Swap forwards (FWCM)
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SHORT END & LONG END OF THE CURVE 10
IR probabilities by FOMC dates
(short end of the curve) (WIRP)
Bond Yields Survey (long end of
the curve) (BYFC)
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CREDIT EXPOSURE DRIVERS 11
Financial leverage &
Earnings volatility
Financial Metrics &
Ratios
Credit Rating &
Outlook
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CREDIT MONITORS 12
Top-down credit
monitor
Cross Asset Monitor: CDS,
Equity, Credit Ratings
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HEDGING STRATEGIES
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INTEREST RATE EXPOSURE HEDGING STRATEGIES
14
Interest Rate Exposure Hedging Strategies
Hedging Strategy
Options (Caps/Floors/Swaptions)
Cost known upfront.
Depending on market conditions it
might be "cheaper" solution
Option termination value subject
to negotiation
Treasury lock / bond forward /
reverse repo
Forward / Starting Swaps
On the run Treasuries-
most liquid instruments
Off-the-runs are less liquid than
the on-the-runs
Close out calculation subject to
negotiation. Exposed to swap
spread. Subject to CVA charge
Requires active management,
rolling. Subject to Initial &
Variation Margin
Limited tenors, could result in
duration mismatch
Option termination value subject
to negotiation
Might introduce swap spread
basis. Termination value subject
to negotiation
Very Liquid
Cost known upfront.
Depending on market conditions it
might be "cheaper" solution
Interest Rate Swaps
Eurodollar Futures
Treasury Futures
Options (Caps/Floors/Swaptions)
Customizable.
Could be perfect hedge.
CCP clearable or OTC
Very liquid up to 2Y
Liquid - most banks will do
markets.
Cost known upfront
Fully Customizable
Pros Cons
Cu
rren
t E
xp
osu
re
Long/Short Treasuries
& Gov Bonds
Limited Tenors.
Possibility of duration mismatch
Fu
ture
Exp
osu
re
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CREDIT EXPOSURE HEDGING STRATEGIES 15
Corporate Bonds
w/ different
tenor/securitization
CDS
Index CDS (CDX IG/HY)
Peer Bonds
It works to a degree for High Yield
issuers
Not a good strategy for Investment
Grade and Distressed Debt
In some cases liquid instruments in
most developped markets
Spotty Liquidity. Shorts might be
subject to oversight
Equity Derivatives
Spotty Liquidity. Shorts might be
subject to oversight
In some case exhibit better liquidity
than bonds (negative bond basis).
Transparent standart terms. Standard
Refence Obligation (SRO)
Limited universe of active CDS market.
Subject to counterparty risk
Diversified exposure. Very liquid and
transparent pricing. Deep market.
Standard terms & trades electronically.
Removes Counterparty risk
Diversified Exposure with limited tenors
In some cases liquid instruments in
most developped markets
Credit Exposure Hedging Strategies
Hedging Strategy Pros Cons
Liquid instruments in developed
marketsShorts might be subject to oversightSovereign Bonds
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HEDGING MARKET EXPOSURE: GM BOND CASE STUDY
16
HR per instrument (futures /
treasuries) (FIHR)
Hedging Credit and
IR Risk (HGBD)
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HEDGING STRATEGY: LIQUIDITY
17
Avg Daily Volume
Current Volume Avg Hist Vol at Time
Open Interest
Daily Volume
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COUNTERPARTY RISK MANAGEMENT -
IRS CASE
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COUNTERPARTY RISK: SWAP CASE
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CREDIT CHARGES: CVA/DVA
20
Bilateral credit charge
DVA adjusted MTM
CVA/DVA/ Bilateral
Running Spread
Bilateral Calculation
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POTENTIAL FUTURE EXPOSURE – EPE & ENE SPOT AND FORWARD CVA, PFE
21
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INTEGRATED TREASURY RISK
MANAGEMENT
22
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QUANTIFYING MARKET
&
CREDIT RISK
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QUANTIFYING EXPOSURES
24
Financial Risk
VAR Analysis
Historical VAR
Expected Shortfall / Tail Risk
Marginal & Incremental VAR
Greeks
Duration / Key Rate Risk (DV01, CS01)
Convexity
Scenario Analysis
“What If” / Factor Stress
Scenario Analysis
Historical Events
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MARKET RISK: KEY RATE BUCKETING
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MARKET RISK (SHOC): STRESS-TESTS
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VALUE-AT-RISK: MARS 27
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HISTORICAL VAR: EXPECTED SHORTFALL, IMPLICIT CORRELATIONS
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Counterparty Risk
Cleared Swaps: Initial Margin (LCH/CME)
(Uncleared) OTC Swaps
0% collateral: CVA / PFE
Partial collateral
100% collateral
(Stringent CSAs)
CREDIT RISK EVALUATION 29
Margin Optimization:
by portfolio netting
- CSA Shopping for
Foreign Banks
- Risky Curve Discounting
- Min Threshold
- Min Transfer Amt
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COMPARING CVA CHARGES 30
Assume 5yr Swap with NPV = $1MM
Collateral Posting Frequency CVA Peak Exposure
No Collateral 110,248 1,016,972
Quarterly with 10K Threshold 8,038 88,735
Quarterly 7,391 78,338
Daily Collateral 3,133 28,349
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COMPARING CVA CHARGES 31
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COMPARING CVA CHARGES: QUARTERLY COLLATERAL POSTING
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OIS DISCOUNTING: TO REFLECT RETURN ON COLLATERAL
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INITIAL MARGIN OPTIMIZATION 34
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Regulation: Swap Trading
Mandatory Clearing
Electronic Venue: SEF
FCM (Bank)
Clearinghouse (LCH/CME)
Mandatory Reporting
REGULATION & ELECTRONIC TRADING 35
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ALLQ: SWAPS ELECTRONIC TRADING
SEF -> FCM -> CLEARING
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ANNEX: CORE TREASURY TOOLS
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ANNEX: TREASURER CORE FUNCTIONALITY (1)
Interest Rates Analysis & Risk Management
RRRA/BSR/FPA – Repo /Treasury Lock/ Bond Forward
SWPM – Interest Rates Derivatives Pricing Engine
WIRP – Short term interest rates probabilities
ICVS – Swap Curve Builder
FWCM – Forward Curve Matrix
FXFA – FX-Interest Rate Arbitrage
WIR – World Interest Rate Futures Monitor
WS – World Swaps Monitor
VCUB / NSV – Volatility Surface
XCF – Cross-Currency Funding / Spread Matrix
Foreign Exchange
WCR – World Currency Rates
FXFC - FX Forecasts
FXFM – FX Rate Forecast Model
FXEX – FX Exposure Capture
OMST- Most Active options strikes and sizes
FRD – FX Forward Calculator
FXIP – FX Information Portal
HWIZ – Hedging wizard
SDRV – Options & NDF transaction volumes
Commodities
FDM – Commodities Fundamentals
CPLY – Commodity playbook by commodity type
CFVL – Commodity fair value
CCRV – Commodity curve analysis
OVML - Option and Forward Analytics (FX/Commodities)
GAS / AGS/ OIL / MINE – Nat Gas/ Agri / Oil / Metals tools
38
General
BPS – Bloomberg Resource Center – docs, videos workflows
Corporate Finance & Capital Structure
LEAG – Overview of top underwriters
FIW /COMB – Bond portfolio pricing, performance, relative value
LOAN / COV - Loan Monitor & covenant information
TDH – Historical liquidity (spread to bench, trade volumes)
DES – Instrument & Issuer description, schedules, covenants
NIM - New issue monitor
NIA – New issue analytics
DDIS – Debt distribution profile for Corp & Sovereign
CRV/CRVF – Curve construction & Curve depository
YAS – Yield and Spread analysis
WACC - Weighted Average Cost of Capital
CAST – Capital Structure
FA – Financial analysis
EQRV – Equity Relative Value
FIRV – Fixed Income Relative Value
QMGR – Quote manager
IMGR – Inventory & pricing
CACS – Corporate actions calendar
MA / PEM – Mergers & Acquisitions, Private Equity portals
CF – Company filings
Credit Analysis & Risk Management
WCDS – World CDS monitor
FICM – Fixed Income Credit Market
SOVR/SRSK – Sovereign Credit Risk Monitors
DRSK – Market vs. Model Default Risk & Probabilities
DRAM – Bloomberg’s Default Risk Ranking
CDSW – Credit Default Swap Valuation
CDSV – CDS term structure
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ANNEX: TREASURER CORE FUNCTIONALITY (2)
Electronic Trading & Hedging Analysis ET/ FIT/ FXGO / TSOX– Electronic trading portal & tools FIT/RFQ/RFQC – Trading quotes for Rates, FX & Commodities RUNZ / IMGR / QMGR – Dealer pricing, inventory and quotes CTM – Futures contract table menu SDR/ SDRV – Swap Data Repository: transaction transparency BEMS – Bloomberg Execution Management System
News & Market Intelligence BI – Industry, sector and company analysis TNI – Advanced news search TOP – Top news READ – Most read news CN – Company specific news FIRS - Economic, industry and markets insight FFM – Functions for the market – practical applications
Search Engines SRCH – Security search CSCH – Convertible search LSRC – Loan search EQS – Equity Screening Investor Relations IR – Investor Relations EE – Earnings Estimate IP – Investor Profile HDS – Company Ownership CAST – Capital Structure AGGD – Debt Holders Documentation, Libraries & MS XL Tools DRVD – Derivatives documentation center XLTP – MS Excel template library FLDS – Bloomberg data field search DLIP – Structured derivatives
39
Counterparty Analysis & Risk Management
CVA – Credit Valuation Analysis
CRPR – Credit Ratings and Outlook Profile
CCA – Credit Comparable Analysis
RATC – Ratings Change
SPLC – Supply Chain Analysis
Portfolio Risk Management & Valuation Tools
MARS – Multi-Asset Risk & Valuation System
BVLI – Bloomberg Valuation Portal
Hedge accounting
HEFF – Hedge Accounting Effectiveness Testing
Forecasting Tools
ECFC – Economic Forecasts
FXFC – FX Forecasts
BYFC – Bond Yield Forecasts
BDVD – Dividend Forecasts
LEAD – Leading Economic Indicators
CPFC – Commodity Price Forecast
Monitors
MMR – Money market rates monitor
CENB / FED – Central Banks
SOVM/USSW/BTMM/PX1 – Sovereign debt monitors
DMMV/EMMV – Developed/Emerging markets monitors
FCON – Financial conditions monitors
OMON – Options monitor
GV / HGV / SKEW –Volatility analytical tools
OVDV – Volatility surface
WCR – World currency rates
IFMO – Inflation monitor
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THANK YOU YON VALTCHEV [email protected]
+1-212-617-1804