The Hindu Business Line : Haircuts and jumps in global financial risk management

The Global Financial Risk Management team of Barclays Capital. That's where Gaurav Aggarwal of the Indian Institute of Management, Bangalore, will be joining in London, at a record salary of $1,93,000 (about Rs 86 lakh) per annum.

If, like me, you also want to know what `global financial risk management' is, our first stop should be www.barcap.com, the site of Aggarwal's employer, where a page is devoted to the topic on hand, under `Campus Recruitment: Analysts'.

"At Barclays Capital we incur financial risk every day in our day-to-day business — either taking or transferring a certain amount of risk as part of our service. Successful risk management requires keeping abreast of the markets, company fundamentals as well as client relationships," explains the page. They place `great emphasis' on evaluating and managing financial risk, the job of the Global Financial Risk Management group.

MANAGING RISK

But how is financial risk managed? By calculating both market and credit risk. Up against two hills, you'd fret, but here's help. The first, that is, market risk is about "the potential impact of changes in the market for traded instruments". Thus, if the market moves against your positions, finance takes a hit.

"Market risk is risk that cannot be diversified away," says Financial Glossary on www.bloomberg.com. "Market risk reflects the possibility for the future earnings to be affected by a change in market price, due to movements in interest or exchange rates," explains Quanto Financial Technology on www.equanto.com.

Resuming the BarCap discussion, the second component of financial risk, viz. credit risk "assesses and quantifies the financial and business risk involved in lending or dealing with our clients". To manage this risk, you must understand "the client and its potential for default". Credit Risk assesses the financial and business risk involved in lending to particular counterparties, explains BarCap in a different page under `Quantitative Associates'. Relevant factors include "company's competitive position within its industry, strategic direction, management quality and financial profile".

FIVE-STEP PROCESS

Since our discussion is about `risk management', it is worthwhile knowing that the phrase refers to analysing exposure to risk and determining how to best handle such exposure, as www.investorwords.com notes. "A definitive generic description of risk management that originated in Australia and New Zealand, now being taken up in many other countries, is set out in the Australian & New Zealand Standard 4360:2004," informs http://en.wikipedia.org, citing www.standards.com.au. The core of the risk management process is a series of five steps: "Establish the context, identify risks, analyse risks, evaluate risks, and treat risks."

Barclays Capital elaborates that risk management involves keeping abreast of the markets, company fundamentals and client relationships. The job needs skills such as "communicating with trading desks about their risk strategies and preparing management reports on risk". Take a deep breath, because "it is essential to be able to stay calm under pressure and pay close attention to detail." You'd appreciate that it is too risky to lose your cool, especially when dealing with high-risk matters.

"Working within either market or credit risk requires strong quantitative analytic abilities to review, assess and make decisions based upon your analysis of large amounts of information," alerts BarCap. "This requires taking an interest in markets and how they move, as well as current events — anything that could cause the market to fluctuate."

DEMANDING ENVIRONMENT

And there's lot more demanded of those aspiring to rub shoulders with Aggarwal and his tribe. Such as: `creativity and problem solving', `ability to work under pressure' (once again), `strong numeracy skills', and an ability to do `a great deal of financial modelling and company-specific credit analysis'. These, apart from `time management and the ability to work as a team'.

One of the four `profiles' on www.barcap.com is of Ryan Dickey, Analyst, Global Financial Risk Management, Credit Risk, New York. "When I started I knew nothing about the finance world. I knew what a stock was and had an idea about what a bond was and that's it," he states. "Now, I am analysing and assessing trades in virtually all major financial markets including equities, fixed income, commodities, structured credit, mortgage backed securities, and interest rate derivatives." He considers as his biggest `work' achievement the developing of `a more accurate methodology to `haircut' bonds".

Haircut, you'd learn from Derivatives Dictionary on www.margrabe.com, means "the excess of an asset's market value over either (a) the regulatory capital value or (b) the loan for which it can serve as adequate capital." It is "industry term for the valuation of securities used to calculate a broker/dealer's net capital," says Bank One Online's glossary on www.bankone.com.

"The haircut will change depending on the class of a security, its market risk, and the time to maturity. The haircut may fluctuate from 0 per cent to 30 per cent (common for equity securities) to 100 per cent for fail positions (securities with past due delivery) that have prospect of settlement."

FUTURE READ

Catch up with the syllabus for `Global Financial Risk Management Using Forwards, Futures, SWAPs, and Options' on www.business.ku.edu. PwC's Market Risk Management Solutions are on www.pwcglobal.com, where you'd know that they use Value-at-Risk (VaR) framework, `an industry standard for measuring market risk'.

GARP (generally accepted risk principles) is explained in a dated report on www.riskreports.com. But www.garp.com is the site of Global Association of Risk Professionals, now celebrating its tenth anniversary, with more than 50,000 members. `Today's Top Risk News' on its homepage begins with, `Commentary — Transforming Indian Banks, the Missing Pieces', an article by Hari Krishna Gururajan, dated March 13.

Our last stop is at www.fame.ch, at a page announcing 2005 Ph.D. Graduates, where Peng Cheng appears first. He is a Manager in the Global Financial Risk Management team of Barclays Capital in London, and his thesis is titled `Linear-Quadratic, Jump-Diffusion Modelling and Its Applications in Finance'.

Peng's research interests are `linear-quadratic, jump-diffusion, modelling option and pricing risk management'. If you're jumping with interest already, let me suggest a reading of `Calibration of Jump-Diffusion Option Pricing Models: A Robust Non-Parametric Approach', a research paper by Rama Cont and Peter Tankov on http://papers.ssrn.com, which shows that "the usual formulations of the inverse problem via nonlinear least squares are ill-posed and propose a regularisation method based on relative entropy".

ZeroBase@TheHindu.co.in

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