TTRISKWATCH - Complex Financial Risk Management

Analyses of scenarios

With the help of freely definable scenarios, the influence of market variations upon the market value and the size of future cash flows can be investigated. This answers ”What-if” questions.

To this end, change scenarios for exchange rates and interest rates can be defined and applied to the rates for the market data. Standard scenarios, such as the parallel shift of the interest rate curve or the devaluation of the corporate currency compared to all other currencies, can thus be illustrated in the same way as complex, individual assumptions.

In the scenario analysis for market values, various scenarios can be compared against one another. For each scenario, the selected portfolio of TTCONTRACT transactions, currency holdings and liquidity forecasts can be reassessed, and the absolute and relative change of value can be determined.

In the analysis of cash flows expected from interest rate transactions, the interest scenarios or the forward rates derived from these are used to predict the size of future variable interest. The strength of the variations in this prediction can be measured in tm5 with the cash flow at risk.

Value at risk

During the analysis of scenarios, variations in market value are investigated using self-selected changes to interest and exchange rates. The question behind the value at risk is, however, which variations in market value  are to be expected with which probability in the worst case. For a portfolio made up of interest and exchange transactions with a market value of 2 million Euros, one answer could be, for instance: With a probability of 95%, the value of the portfolio will not decrease by more than 120,000 Euros within 3 days. The 120,000 Euros are the potential value at risk, which is calculated on the basis of the selected parameters: confidence level (95%) and duration considered (3 days).

The value at risk can be calculated separately for interest and exchange rate risks, as well as in combination for both types of risk. Typically, when determining the overall risk via different types of risk or different sub-portfolios, there is a diversification effect, i.e. the total risk is less than the sum of the individual risks.

To determine the value at risk in tm5, there is a variance-covariance approach available and, indirectly, the option of Monte-Carlo simulations. All of the necessary statistical parameters such as variances and covariances of the risk factors used can either be imported or calculated from existing market data.

Sensitivities

For the complex transactions involved in the management of interest and exchange rates, various sensitivity parameters can be calculated in tm5. These approximately describe the behavior of the market value when the parameters relevant for the analysis change. For options, the "Greeks" are determined as a measure for the reaction of the option value to changes in the value and the volatility of the underlying, the interest rate and the time. For interest rate transactions, if there is a parallel shift in the interest rate curves, the duration and the convexity measure the change of the market value.