block: derivatives, financial markets and balance management education... · such as the put-call...
TRANSCRIPT
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Permanent education
Block: Derivatives, Financial Markets and Balance Management
Coordinator: Drs. Eric Mathijssen
Shadow coordinator: Drs. Robert Daniels
In this block, the balance management of financial institutions is further explored. For this, students
learn to understand the structure and processes of financial markets and financial products and to
identify and manage the risks arising from this. Students learn quantitative methods and techniques for
valuing derivatives and how these derivatives are embedded in financial products. Students learn to use
this knowledge when covering financial risks of products and institutions. Here, attention is explicitly
paid to the role of the participants in markets and their contribution to behavioral risk.
Derivatives, Financial Markets and Balance Management
Derivatives
- Students learn to understand and use quantitative methods and techniques for valuing derivatives.
Students learn how derivatives are embedded in financial products and the effect on the risk of products
and organizations.
- Students learn to use this knowledge when covering financial risks of products and institutions.
Characteristics and functioning of financial markets
- Students learn to understand the structure and processes of financial markets and financial products
and to identify and manage the risks arising from this.
- Students learn to understand the role of the participants in those markets and their contribution to
behavioral risk and to identify and manage the risks arising from this.
Balance management
- Students learn methods and techniques of balance management for banks, insurers and pension funds,
and to use them.
- In the cases, the theory is applied to and tested against practical situations. It is learned when and how
these techniques are better and less useful. And how to apply this in practice. Students learn to write
and present details in a concise and purposeful way.
Overview lectures
Subsequently, a (short) description of the content is given for each lecture.
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Lectures 1 to 5
Date 5, 12, 19, 26 September and 3 October 2018
Time 19: 00-22: 00
Location Agora 2
Title Derivative theory
Teacher Michiel Lodewijk and Norman Seeger
Content
Derivatives are financial instruments that derive their value from the value of another underlying asset
(e.g. share prices, interest rates, inflation, temperature or creditworthiness). Derivatives can be used for
various purposes, such as risk management (covering positions), speculation, arbitrage or the creation of
synthetic positions. The most well-known derivatives are forwards, swaps and options. In recent years,
the size and complexity of derivatives (markets) have increased considerably. It is therefore also
important to have a good understanding of the basic principles of derivatives. John C. Hull writes in his
book: "One way of ensuring that you understand that a financial instrument is to value it. The basic
principles of derivatives are elaborated in this lecture series from an economic perspective.
The starting point for valuing derivatives is arbitrage theory. This results, under certain assumptions,
that when valuing derivatives, it can be assumed that investors are risk-neutral, ie not risk avers or risk-
seeking. In the valuation, a further distinction can be made between the so-called risk-free value of a
derivative and the observed price. In the price observed, various risks / costs have been included in the
price since the financial crisis.
A number of technical concepts are discussed that follow from the principles of the arbitrage theory,
such as the put-call parity, the binomial model and the Black-Scholes-Merton (BSM) model. The
sensitivities of option positions on the basis of the Greeks are also discussed and the modeling of
volatility is discussed. Mandatory literature Hull, John C., "Options, Futures and other Derivatives", 10th
global edition, Pearson.
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Lecture 6
Date October 9, 2018
Time 19.00-22.00
Location Forum 2
Title Designing an operational Risk Framework
Teacher Rik Ghijsels
Central question
How do you set up an effective operational risk-based framework for derivatives?
Content
Operational risk occurs in all companies and contains a very broad definition related to risks from
internal processes, people, systems and external events. In this course, the crucial importance of
managing operational risks for derivatives will be indicated on the basis of a number of practical
examples. In the past, operational risk management was often of less importance than the attention
paid to market and credit risk. Also the management of operational risk was often reactive, while a
proactive approach could contribute to a more optimal and profitable business.
Setting up an operational risk framework is the basis for managing and mitigating operational risks. The
various building blocks of a well-functioning operational risk framework will be discussed, such as
governance, risk assessments, loss database, risk indicators and risk reports. In order for these
theoretical building blocks to be successful in practice, the framework must be implemented and
accepted within the entire organization in the various business processes. This will also address the
necessary change in culture to identify and prevent operational risk.
Learning objectives
After this course, students can:
- Identify the main building blocks of an operational risk framework
- Display a further elaboration of these building blocks
- Indicate which culture changes are necessary for the successful implementation of an effective
operational framework
Literature
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- Philippa X. Girling: Operational Risk Management: A Complete Guide to a Successful Operational Risk
Framework 1st Edition Chapter 1 through 10, Chapter 11-18.
- How does DNB assess the management of operational risks at companies? including Self-assessment
spreadsheet
http://www.toezicht.dnb.nl/3/50-229146.jsp
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Lecture 7
Date October 16, 2018
Time 19.00-22.00
Location Forum 2
Title Balance Sheet Management for Pension Funds
Teachers Manon ten Voorde and Eric Mathijssen
Central theme
To experience the financial dynamics of a pension fund's balance sheet through a simulation
Summary
Staying on a robust policy with PensionSim
With a robust policy, a pension fund can be rescued under all circumstances. If the economy is against or
against, but also in extreme events. With PensionSim's simulation, you as a director of a pension fund
test your investment strategy in different scenarios. You live through the unpredictable reality of
everyday life and you gain a wealth of practical experience.
With the PensionSim you as a driver are at the controls yourself. As the head of a fictitious pension fund,
you put together the portfolio with your team. You select the instruments to realize your fund targets,
taking into account changing circumstances. The simulation accurately mimics reality. You therefore
need all your insight to guide your pension fund to a safe haven.
PensionSim is not an investment game with the aim of achieving the highest funding ratio. However, the
simulation tests whether the player conducts a stable policy, in line with the set goals and limits. You
control the fictitious pension fund for fifteen years. This is possible because a month in the game, for
example, takes 30 seconds. You can adjust the investment mix, hedge market risks and decide on
indexation, while stock prices, interest rates and inflation will rise and fall.
PensionSim is designed because it is crucial for risk managers to look critically at policy and ensure
robustness. The future is uncertain and unpredictable. With a resilient strategy, fund managers can
however prepare for this. The empathy with the practice in this simulation contributes to this.
Study aim The added educational value of PensionSim is that participants playfully learn how to deal
with risks. By playing the simulation, participants experience the importance of thinking beforehand
about and determining risk appetite and degree of hedging. In addition, the game provides insight into
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decision-making processes within a board. After all, the quality of this is leading to the outcome of the
pension fund.
Literature
None
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Lecture 8
Date October 30, 2018
Time 19.00-22.00
Location Forum 2
Title Balance Sheet Management for Insurance Companies
Teacher Jeffrey Hennen
Central question
How is the balance of an insurer managed in practice? '
Content
Insurers are under severe pressure due to the recent crises on the financial markets, the changing
demand for insurance products and new laws and regulations. The manager of an insurer must take into
account various stakeholders (policyholders, shareholders, employees) and various financial frameworks
(Solvency II, IFRS, S & P). The management of an insurer's balance sheet has thus become a complex
undertaking.
The balance of the insurer is central in this course. We look at how the risk appetite of the insurer is
defined and how the risk appetite is converted into practical guidance. Which risks are accepted and
which risks are covered? Which instruments are used to cover those risks?
A complicating factor in steering the balance is that a balance can be looked at in different ways.
Legislation and regulations (Solvency II) must be complied with, but the insurer must also steer an
economic framework in order to remain viable in the longer term. Elements from Solvency II - such as
the UFR and the Volatility Adjustment (VA) - make the management of the balance more complex in
practice. Regulations can ensure that hedging is not optimal economically.
An additional complicating factor in steering the balance sheet is the presence of embedded options and
guarantees in the products of (mainly) life insurers. By means of a case that the students themselves
develop during the lecture, a number of techniques are used to determine the (market) value of these
embedded options and guarantees.
Learning objectives
The student must:
- knowing the balance sheet of an insurer and identifying the most important risk drivers;
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- to understand the differences between (financial) frameworks and to explain how these balance
controls complicate;
- Understand how an insurer should balance risk and return in order to remain viable in the long term;
- understand what embedded options and guarantees are, and which techniques can be used to value
them.
Literature
- Bouwknegt, Pieter, "Built-in options in life insurance", July 2003, De Actuaris
- Bouwknegt, Pieter, "Balance management at an insurer", January 2011, De Actuaris
- Frans de Weert, Bank and Insurance Capital Management, Wiley 2011 (H1, 2.2, 3.2, 8.2 - 8.3, 10.5 -
10.7.17)
Additional literature
PwC, Banana Skins Insurance 2015
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Lecture 9
Date 6 November 2018
Time 19.00-22.00
Location Forum 2
Title Balance Sheet Management for Banks
Teacher Jaap Karelse
Central question
How does a bank manage and optimize its balance sheet? Which risks are weighed and controlled?
Content
Balance sheet management at banks, also referred to as 'Asset & Liability Management', has received
increasing attention in recent times for various reasons. Measuring and managing the various risks on
the bank balance sheet (the banking book) is a process that has to take into account more and more
requirements and preconditions. The amount of regulation in this area has increased considerably and is
still developing further. While activities in trading books have received relatively much attention in
recent times, banks have been relatively free to manage the activities in the banking book at their own
discretion. In the meantime, the recent requirements from EBA and BCBS have changed in this area. The
exact interpretation of these requirements varies from bank to bank and is in most cases still 'work in
progress'.
This course will further discuss the ways to look at the various activities in the banking book from a risk
management perspective. The consistent measurement of the exposures and risks of these activities is
discussed, as well as the dilemmas in achieving a compromise between complexity and manageability.
Account will have to be taken of the capital and liquidity requirements and also the return targets as
expected by the market.
How can these risks be managed with, for example, derivatives, and how can they be used in practice?
We will discuss the various ways in which the management of these risks is looked at, for example from
a value or income perspective, or from a risk-neutral or 'real world' perspective. We will see that there is
no fully optimal solution, but that choices must be made, both strategically and modeling. The recent
proposals from the regulator will also be taken into account.
In addition to this lecture, a lecture entitled 'Balance management in practice' is planned on 20
December, in which the substance discussed in this lecture is further elaborated and tested in
simulation form.
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Learning objectives
Recognizing the different risks on a bank balance:
- Insight into the ways in which these risks can be modeled for the various activities on the balance sheet
- Gain insight into the different perspectives and preconditions in managing these risks, and the
weighing of risks and rewards from a strategic perspective
- Determine what consequences new regulations have on balance management
Literature
Chapters 8 and 9.1 of 'Risk management in banking' by Joël Bessis, fourth edition
- Guidelines on the management of interest rate risk arising from non-trading activities, 22 May 2015,
EBA
- 'Standards - Interest rate in the banking book', 12 April 2016, Basel Committee on Banking Supervision
- 'Managing interest rate risk for non-maturity deposits', Marije Elkenbracht, Bert-Jan Nauta, AsiaRisk,
December 2006-January 2007
- Interest Rate Risk in the Banking Book, Paul Newson, 2017
Optional literature
Webinar 'Fundamentals of financial risk management'
https://youtu.be/4vZ01BaoXUY
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Lecture 10
Date November 13, 2018
Time 19.00-22.00
Location Forum 2
Title Central Clearing and OTC Derivatives
Teacher Robert Daniëls
Central question
What is the role of Central Counterparties? How do they reduce systemic risk?
Content
Financial derivatives are used by financial companies to manage their balance sheets. After the financial
crisis in 2008, regulators around the world questioned the role of bilateral OTC derivatives. What risk
does a financial institution run with certain derivative positions and as a consequence what systemic
risks are voting from these derivative transactions? One of the proposed solutions by the G-20 was to
reduce systemic risks by:
i) making bilateral transactions more costly; and
ii) introducing new regulations for Central Counterparties (EMIR) with the aim of letting CCPs play a
more important role in the overall market.
The key focus of regulators is mitigating counterparty risk and reducing systemic risk. However, what
risks do you have?
This lecture focuses on CCPs and provides insight into the liquidity and counterparty risks. On the other
hand we will see that we can never be excluded and is often transformed. The aim of the lecture is to
discuss how end-users can protect themselves from the CCPs.
Learning objectives
After this lecture, students are able to
- Understand EMIR, the role of CCPs and how counterparty risk is mitigated
- Analysis the risks inherent in OTC derivatives and mandatory clearing regimes
- Understand the impact collateral management requirements have on balance sheet management
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- Understand contingent liquidity risk and alternative approaches to managing it
Literature
- DNB, 2013, "all Ins & Outs of CCPs", http://www.dnb.nl/binaries/All_Ins_Outs_CCPs_tcm46-
288116.pdf
- DNB Points of attention, 11 August 2014.
http://www.toezicht.dnb.nl/binaries/50-231107.pdf
Optional literature
- IMF, 2010, "Making Over-the-Counter Derivatives Safer: The Role of Central Counterparties"
- Economist, 2012, "Centrally cleared derivatives: Clear and present danger"
https://www.economist.com/finance-and-economics/2012/04/07/clear-and-present-danger
- Economist, 2012, "Derivatives markets regulation: Unintended consequences"
http://www.economist.com/blogs/freeexchange/2012/09/derivatives-markets-regulation
- DNB EMIR (European Market Infrastructure Regulation):
https://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2012:201:0001:0059:EN:PDF
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Lecture 11
Date November 20, 2018
Time 19.00-22.00
Location Forum 2
Title High Frequency Trading
Teacher Rik Ghijsels
Central question
What influence do the changing market structure, the increase of High Frequency Trading and the
growth of Exchange Traded Funds on the exercise of risk management have?
Content
From practice, this course will deal with a number of developments in the financial market. This
provides insight into examples of the changing market structure, the emergence of new trading
techniques and the emergence of new products. The first part discusses the changing market structure,
the emergence of new trading platforms and the impact of the regulation of over-the-counter
transactions and the central clearing of these instruments. Next, it will be discussed how the changing
market structure has contributed to the development of high frequency trading. Different aspects of
high frequency trading will be treated as well as the recent publicity surrounding the advantages and
disadvantages of this trading technique. In the second part we will discuss the development of Exchange
Traded Funds, a product that has gained enormous popularity in recent years.
In addition to gaining insight into these new developments, the link will be made how the changing
market structure, the emergence of high frequency trading and the creation of ETFs have an impact on
managing existing risks or creating new risks.
Learning objectives
After this lecture participants will be able to:
- Identify the main developments of the past decades in the market structure.
- Explain what high frequency trading is and to describe the most important characteristics
- Identify hidden risks in ETFs
- Identify risk mitigation measures related to the above developments
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Literature
Equity Trading in the 21st Century (2010) Angel, Harris & Spatt
http://modernmarketsinitiative.org/wp-content/uploads/2013/10/Equity-Trading-in-the-21st-
Century.pdf Guide to the Development and Operation of Automated Trading Systems
https://fia.org/sites/default/files/FIA%20Guide%20to%20the%20Development%20and%20Operation%2
0of%20Automated%20Trading%20Systems.pdf
Optional literature
FIA European Traders Association: https://epta.fia.org/
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Lecture 12
Date November 27, 2018
Time 19.00-22.00
Location Forum 2
Title The impact of Central Banks on Financial markets and liquidity
Teacher Jan Willem van den End
Central question
What role do central banks play in financial markets, what impact do the unconventional monetary
measures have and what are the consequences for financial institutions?
Content
In this course we will discuss in detail the role that central banks have in the financial markets. We deal
with the objectives and transmission channels of monetary policy (in particular the Eurosystem), with
particular attention to measures taken by central banks since the financial crisis. In addition, we look
from the financial institution on how the various monetary measures affect market risks and how
central banks can feed the other banks with liquidity or take other stabilizing measures. Finally, we look
at the future: what risks can we expect from the current developments in the financial markets and for
which challenges does this mean the central bank.
Learning objectives
After this course, students can:
- Identify the policy objectives of central banks.
- Explain the role and influence of central banks on financial markets.
- To gain insight into the effects of monetary policy on financial markets and on the risks for financial
institutions.
- Understand the effect of stabilizing and mitigating measures by central banks.
- To be able to discuss risks in the financial markets and their interaction with the monetary policy of
central banks.
Literature
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DNB Occasional Study Nr. 3 (2016): Importance and significance of inflation in the euro area, chapters
1,2 and 5.
https://www.dnb.nl/en/binaries/1605458_OS14-3_ENG_v9_tcm47-346543.pdf
Optional literature
- De Haan, Van den End, Frost, Pattipeilohy and Tabbae (2013). Unconventional Monetary Policy in the
Financial Crisis: An Assessment and New Evidence, SUERF 50th Anniversary Volume Chapters, SUERF -
The European Money and Finance Forum - Borio and Disyatat (2009), Unconventional monetary policies:
an appraisal, BIS Working Papers 292
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Lecture 13
Date December 4, 2018
Time 19.00-22.00
Location Alma
Title Hedge Fund risk management
Teacher Patrick Bronger
Central question
What risks do the investment strategies that hedge funds follow and what lessons can be learned from
the Madoff Hedgefund debacle? "
Content
Hedge funds have existed for decades and are especially highlighted when a debacle or crisis occurs with
Hedgefunds from reputable investors as seen at LCTM and Madoff. This course will further discuss the
ways in which Hedge Funds conduct their activities and risk management in this respect.
This course first deals with the categorization and description of the different types of strategies that
Hedgefunds follow. Then we discuss the statistical characteristics of the returns with attention to the
non-normality and the various biases. We go deeper into a few strategies to better understand the
underlying factors.
The second part of the course consists of a case about the Madoff debacle. What went wrong with this
Hedgefund and what were the red flags that were overlooked? How can risks be better controlled? We
will discuss the various ways in which the management of these risks can be looked at. After a short
introduction including a video, a number of questions are worked in groups. After all, the most
important lessons from the case are discussed in plenary.
Learning objectives
After this course, students can:
- Identify the most important hedge fund strategies and know what risks they bear.
- Name the characteristics of reported hedge fund returns and know which biases and risks they should
and should not take into account.
- Reproduce the main elements of the Madoff-Hedgefund debacle and apply the lessons that follow.
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Preparing
- Bernie Madoff's Ponzi Scheme: Reliable Returns from a Trustworthy Financial Adviser, by Dennis
Collins.
- Madoff case exhibits 0072 and 0076.
Literature
- Jorion, P., Financial Risk Manager Handbook, Wiley Finance 2009, fifth edition, (chapter 17), Wiley
Finance 2011, sixth edition, (chapter 30), on "Hedge Fund Risk Management".
- Ilmanen, A., Expected Returns, Wiley Finance 2011, p. 226-241.
- Case Study. Bernie Madoff's Ponzi Scheme: Reliable Returns from a Trustworthy Financial Adviser, by
Dennis Collins.
- Madoff case exhibits 0072 and 0076.
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Lecture 14
Date December 11, 2018
Time 19.00-22.00
Location Forum 2
Title Structred Credits
Teacher Jac Kragt
Central question
How did the credit crisis arise and what role did structured credit, correlation and liquidity play in this?
Lessons for risk managers.
Content
One of the wise lessons of the credit crisis is that there are restrictions on the provision of credit. This
lecture explains the causes of the credit crisis and the structured credit that play a role in this. It turned
out that the quantitative models did not pick up the systemic risk and that the underlying risks in the
products were not sufficiently considered in the risk analyzes. Moreover, the financial system had built
up more leverage than seemed at first glance. This course describes the origin and course of the credit
crisis.
We discuss financing channels and correlations, both in the financial system (securities within financial
institutions and between financial institutions) and correlations in structured credits (in the technical
sense) such as MBS / ABS and CDOs.
Learning objectives
After this course, students can:
- Reflect on risk management before the credit crisis and its occurrence
- Awareness what it means to be part of an interwoven system of financial institutions
- Assessing risks associated with structured credit
- Assessing risks in addition to mutual correlations between products
Required reading
- Kragt, Jac. 2008. The Credit Crisis, Eburon, ISBN 9789059722576
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- Adrian & Shin 2010; Liquidity & Leverage, JFI.
http://www.newyorkfed.org/research/staff_reports/sr328.pdf
- Credit Correlation, a Guide, JP Morgan pages 1-20
Optional literature
Kocken: Financial Risk management book Chapter 7: correlation examples
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Lecture 15
Date December 18, 2018
Time 19.00-22.00
Location Forum 2
Title Securitization
Teacher Frank Meijer
Central question
Are structured products "Toxic Waste", which hide and spread the credit risks in the financial system?
Content
Securitized products such as CDOs have a wild time behind them. Whereas in the time of their creation
they were still regarded as splendid solutions to make financial markets more efficient and cheaper in
the time of the end of the 1980s, public opinion has been completely changed since 2007 and
securitized assets in the media are mainly seen as "Toxic Waste". This raises the question of what has
gone wrong in recent years and how risk management has failed so miserably. In this context, many
point to mistakes by the rating agencies, which too easily issued an "AAA" label. But the crisis has shown
that other aspects of risk management for structured products have also failed. Based on historical
developments and practical examples, we will provide an overview of the most important risk
management facets of securitized products and the most recent developments in this course. The new
regulations regarding this category of products and the question of whether they will earn a place on
the balance sheet of financial institutions will also be discussed.
Learning objectives
• Explain how securitized structures work and what risks are involved.
• Understand how it came to the securitization crisis and where risk management has failed
• Indicate which changes in regulations have been implemented to further manage the risks of
securitization
• Underpinning whether securitized assets can continue to play a role in the balance sheet of financial
institutions in the future
Literature
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• Hull, John C., "Options, Futures and Other Derivatives", 8th edition (global edition), ISBN-13:
9780273759072 / ISBN-10: 0273759078; Chapter 24 Credit Derivatives.
• The economist (2007) "Black boxes: investment banks' inventions for transforming risk are ingenious,
but hard to fathom" http://www.economist.com/node/9141547
• The economist (2007) "Securitization When it goes wrong"
http://www.economist.com/node/9830765
• Barclays, Crunching Draghis ABS
Optional literature
• Film: Boom Bust Boom: http://www.2doc.nl/documentaires/series/npo-doc-exclusief/2015/boom-
bust-boom.html
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Lecture 16
Date January 8, 2019
Time 19.00-22.00
Location Forum 2
Title Balance Sheet Management for Banks in Practice (BankSim)
Teacher Jaap Karelse and Thomas Haartsen
Central question
Using a simulation to experience the financial dynamics of the balance sheet of a pension fund
Content
The 'Balance sheet management at banks' course deals with the current methodology for measuring and
managing various risks on the bank balance sheet. The purpose of this follow-up lecture is to further
understand the relationships between variables as value stability or income stability, and the dynamic
nature of the bank balance sheet. The control of a bank balance in practice is central here. The focus will
be on the considerations that have to be made in the management of the bank balance sheet, as well as
the functioning of control instruments.
The case that has already been dealt with in the previous lecture will be used as a starting point for this
lecture and further elaborated. During a simulation game, students will also have to make strategic
decisions to ensure that the bank balance is as good as possible against all kinds of unexpected market
conditions. Choices will have to be made in this respect, whereby, of course, the legal and internal
frameworks must be taken into account. The consistent measurement of the exposures and risks in
practice is discussed during the simulation, and also the dilemmas to achieve a compromise between
complexity and manageability.
Learning objectives
- To gain deeper insight into the dynamic nature of the bank balance sheet
- gaining experience in the management of various risks on a bank balance sheet
- To be able to apply instruments to adjust the bank balance
- Understand connections between various criteria
- Make strategic choices when optimizing bank balance
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Literature
See lecture "Balance Sheet Management for Banks"