1. RYM Finanskonsult AB
How to Manage Financial Risks
Knowing Understanding
Analyzing Living
Organization
and Culture
Business and
Instruments
Risk measures
and Pricing
Performance
Measurements

2. RYM Finanskonsult AB
Knowing Understanding Analyzing Living
How to Manage Financial Risks
Organization
and Culture
Business and
Instruments
Risk measures
and Pricing
Performance
Measurements
Markets
Loans/Dep.
FRA’s
Swaps
Bonds
Futures
Options
Culture
Organization
Policy
Limits
Processes
Risk taking
Risk control
Value-at-Risk
Forwards
R A P M Management
Market
Operational
Business
Credit
Risk Capital
Profit/Loss
Mark.values
Diversify
WACC
CAPM
Valuation
Cash flows
Hedging
Pricing

3. RYM Finanskonsult AB
FX Markets
• Governments
• Central banks
• Financial institutions
• Multinational corporations
• Currency speculators / Arbitrageurs
In the Foreign Exchange (FX) markets are
currencies traded for other currencies. Its by far
the largest financial market in the world. Market
participants are:

4. RYM Finanskonsult AB
Loan
The loan giver ( a bank normally) issues a “loan” to a
customer with a given amount, interest rate and term.
Often does the loan giver require a “collateral” as a security
for the loan.
3-year loan
Amort type: Straight/Quarterly
Loan amount: 28 000 000
Interest rate: 5,50%
Coupon frequency: Quarterly
Coupon base: Actual/365
Interest rate reset No
Start day 2007-10-01
Maturity day: 2010-09-30
0
1 2 3 4 12

5. RYM Finanskonsult AB
Gap analysis
Date
Interest
payment
Amort
Payment
Loan
payment
Sum
Loans
Cum.
Loans
2008-01-01 0 0 1 000 000 1 000 000 1 000 000
2008-03-31 -24 658 -83 333 0 -107 991 892 009
2008-06-30 -47 511 -83 333 1 000 000 869 155 1 761 164
2008-09-30 -46 210 -83 333 -129 543 1 631 621
2008-12-31 -44 110 -83 333 -127 443 1 504 178
2009-03-31 -41 096 -83 333 -1 000 000 -1 124 429 379 749
2009-06-30 -14 543 -83 333 -97 877 281 872
2009-09-30 -12 603 -83 333 -95 936 185 936
2009-12-31 -10 502 -83 333 -93 836 92 100
2010-03-31 -8 219 -83 333 -91 553 548
2010-06-30 -6 233 -83 333 -89 566 -89 018
2010-09-30 -4 201 -83 333 -87 534 -176 553
2010-12-31 -2 100 -83 333 -85 434 -261 986

6. RYM Finanskonsult AB
Gap analysis
-1 500 000
-1 000 000
-500 000
0
500 000
1 000 000
1 500 000
2 000 000
2008-
01-01
2008-
03-31
2008-
06-30
2008-
09-30
2008-
12-31
2009-
03-31
2009-
06-30
2009-
09-30
2009-
12-31
2010-
03-31
2010-
06-30
2010-
09-30
2010-
12-31
Sum Loans Cum. Loans

7. RYM Finanskonsult AB
Present Value
The present value of a certain amount of money is greater
than the right of receiving the same amount at time (t) in
the future.
PV today > PV Future
PVt > PVt + 1
If you got 1.000 Dollars today what must the future amount
in 1 year be if the Investment should be attractive? The
Investors Hurdle rate is 10 %
1000 + (1000x10%) = 1 100
To get 1.100 Dollars in 1 year is equal with having
1.000 Dollars today

8. RYM Finanskonsult AB
Bonds
• Bills – Normally less than 3 years
• Notes – Smaller issues
• Bonds – Long term securities issued to a wider public
A Bond is a debt security, in which the issuer (borrower) owes
the holder a debt and is obliged to pay interest (coupon) and
to repay the principal amount at a decided date.
A Bond is simply a loan that has been formed into a security
and is tradable in the secondary market.

9. RYM Finanskonsult AB
Bond Valuation
The market value of a ordinary straight Bond is determined
by discounting the expected cash-flows of the bond to their
present value using a appropriate discount rate (Zero Coupon
rates).
P = Market Value or Price
C = Coupon
F = Face Value or Principal amount
T = Time periods

10. RYM Finanskonsult AB
Fixed rate Bond
A fixed rate Bond (also called straight bonds)
gives a periodic interest payments (coupons)
during the time to maturity.
Fixed Rate Bond
Principal amount 1 000 000
Coupon 10,00%
Coupon frequency Yearly
Coupon base 360/360
Issue date: 2008-01-01
Maturity date: 2012-12-31

11. RYM Finanskonsult AB
Period/
Year Cash-flow PV-factor
Present
Value
PV-Weight
Duration
1 100 000 0,90909 90 909 0,091 0,09
2 100 000 0,82645 82 645 0,083 0,17
3 100 000 0,75131 75 131 0,075 0,23
4 100 000 0,68301 68 301 0,068 0,27
5 1 100 000 0,62092 683 013 0,683 3,42
Sum: 1 500 000 1 000 000 1,000 4,17
Macaulay Duration price
sensitivity
0,25% increase in yields
Period/
Year Cash-flow PV-factor
Present
Value
PV-Weight
Duration
1 100 000 0,90703 90 703 0,092 0,09
2 100 000 0,82270 82 270 0,083 0,17
3 100 000 0,74622 74 622 0,075 0,23
4 100 000 0,67684 67 684 0,068 0,27
5 1 100 000 0,61391 675 305 0,682 3,41
Sum: 1 500 000 990 583 1,000 4,17
990 583 – 1 000 000 = -9 417
To use Macaulay Duration as a tool for measuring price
sensitivity was a good start but soon did the Market need
more precise solutions
-4,17 x 1 000 000 x 0,25% = -10 425
With 0,25% increase in yields

12. RYM Finanskonsult AB
Gap-analysis Business case 2
UAB Pinigus
-30 000 000
-20 000 000
-10 000 000
0
10 000 000
20 000 000
30 000 000
2008-06-30
2009-09-30
2010-12-31
2012-03-31
2013-06-30
2014-09-30
2018-12-31
Cash changes Sum Deposit Bond Sum Loans Cumulative Gap

13. RYM Finanskonsult AB
Forward Rate Agreement’s
• It’s a Notional contract with no exchange of principal (its
netted) at settlement date
• The fixed rate (or the FRA rate) is the rate at which the
contract is agreed on
• The reference rate (normally LIBOR) is the rate that will
be decided at a future time
• The netted interest payments is paid on termination date
• A combination of FRA´s is a Interest rate swap
The FRA is an interest rate contract. It locks in an interest rate
(fixed rate), either a borrowing rate (buying) or a lending rate
(selling) for a specific period in the future.

14. RYM Finanskonsult AB
Interest Rate Swaps
A swap is an agreement to exchange cash flows at
specified future times according to certain specified rules
The “vanilla” IRS is a derivative in which one party’s exchanges a
stream (legs) of fixed interest payments for an others party’s
floating payments. Normally are no Principals exchanged!

15. RYM Finanskonsult AB
Stocks /Shares
• Ordinary shares with full dividend rights
and full voting right (A-share)
• Ordinary shares with full dividend rights
but fractional or no voting rights (B-
share)
• Preference shares with dividend priority
A share of stock represents a share of ownership in a
corporation. The main types of shares are:

16. RYM Finanskonsult AB
Futures Contracts
• Available on a wide range of underlyings
• Exchange traded
• Specifications need to be defined:
• What can be delivered,
• Where it can be delivered, &
• When it can be delivered
• Settled daily
A Future contract is an agreement between two parties to
buy or sell an asset at a certain time in the future for a
certain price. The future gives the holder the obligation to
buy or sell the underlying asset.

17. RYM Finanskonsult AB
Stock loans
• Stock loans can be used to
• Cover a delivery
• Hedge a position
• To go short in the market
The Stock loans product gives shareholders an opportunity
to lend his shares to a borrower. The borrower has to
return the same amount of shares to the lender after a
certain time. The lender receives a premium for this.

18. RYM Finanskonsult AB
Stock-options
• Insurance / hedge
• Speculative or arbitrage
The option entitles the owner the right (but not obligation) to
buy (call) or sell (put) an underlying asset (stock, bond etc.)
at a predetermined price (exercise or strike) on a future day
(European) or within a future period (American)
The options are used for following purposes:
The premium is normally paid as a flat fee and up front at
the beginning of the option – which makes the options
attractive for sellers

19. RYM Finanskonsult AB
The Black-Scholes formulae
C = value of Call Option and
S = Stock Price
K = Strike Price
s = Volatility
T = Time to expiration
r = Risk-Free Interest Rate
An Stock option value as shown by the Black-Scholes Option
Pricing Formula is exposed to movement in several variables:
The pricing formula for stock options are adjusted for stock
dividends, if they are expected until exercise.
C = ƒ(S, K, , T, r)s

20. RYM Finanskonsult AB
Underlying
price
Intrinsic
ValueTime
Value
Price at expiry
Price before expiry
The option price before expiry
Call
price
Strike
price
Out-of-the-money In-the-money

21. RYM Finanskonsult AB
Types of Strategies
• Take a position in the option and the
underlying
• Take a position in 2 or more options
of the same type (A spread)
• Combination: Take a position in a
mixture of calls & puts (A
combination)

22. RYM Finanskonsult AB
Delta Hedging
• Delta (D) is the rate of change of the
option price with respect to the
underlying
Option
price
A
B
Slope = D
Stock price

23. RYM Finanskonsult AB
Caps and Floors
• Cap is a protection for increasing Interest rates
• Floor is a protection for decreasing Interest
rates
• Caps/Floors are like a option on a series of
FRA’s
• Caps = Calls
• Floor = Puts
• The issuer pays the difference (spread)
between the fixed rate and the reference rate
• Buyer pays a premium

24. RYM Finanskonsult AB
Swaptions
• Option on a Interest rate Swap
• Gives the holder the right to buy or
sell a Swap
• Is a insurance against low or high
interest yields
• The buyer pays a premium

25. RYM Finanskonsult AB
FX Outright
• Settlement (delivery) date
• Exchange rate (forward price)
• Currency pair and amounts
• Payment instructions
An FX Outright (synonym Forward) is a trade made today
but with delivery more than 2 days in the future. The
conditions in the deal must consist of:
The Outright prices are decided by current existing FX spot-
rates and MM interest rates

26. RYM Finanskonsult AB
Yield curves
The break-down of the Bretton woods system initiated an era of floating
currency rates, which made life complicated for bond traders. Marty
Liebowitz at Salomon Brothers (US Investment Bank) started in mid
1970s to draw a curve through all yields instead of think of each maturity
as a separate market place.
3,50%
3,75%
4,00%
4,25%
4,50%
4,75%
5,00%
1
day
2
days
3
days
1
week2
weeks1
m
onth2
m
onths3
m
onths6
m
onths9
m
onths
1
year2
years
3
years
4
years
5
years10
years

27. RYM Finanskonsult AB
Upward-Sloping Yield Curve

28. RYM Finanskonsult AB
The advantage for No-arbitrage models are that they reflect the actual
market prices but their problem is badly behaving forward rates. This is
a problem for economists.
Yield curves @ 1995-12-15
by Boothstrapping
7,60
7,80
8,00
8,20
8,40
8,60
8,80
9,00
9,20
9,40
9,60
15-jun-94 28-okt-95 11-mar-97 24-jul-98 06-dec-99 19-apr-01 01-sep-02 14-jan-04 28-maj-05 10-okt-06
3M Forward Zeros
Spot Zeros
Curve from No-arbitrage
model

29. RYM Finanskonsult AB
Value-at-Risk
• Variance / Covariance method (Risk Metrics)
• Historical Simulation
• Stochastic Simulation (Monte Carlo)

30. RYM Finanskonsult AB
Advantages of VaR
• It captures an important aspect of risk
in a single number
• It is easy to understand
• It asks the simple question: “How bad
can things get?”

31. RYM Finanskonsult AB
Monte Carlo VaR
0
5
10
15
20
25
30
35
40
-5 -4.5 -4 -3.5 -3 -2.5 -2 -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
P/L(MSEK)
Frequency
88
90
92
94
96
98
100
102
104
106
108
110
1 7 13 19 25 31 37 43 49 55 61 67 73 79 85 91 97
Tillgång 1 Tillgång 2
Tillgång 3 Tillgång 4
Simulated prices Price distribution

32. RYM Finanskonsult AB
Stress Testing
• This involves testing how well a
portfolio would perform under some
of the most extreme market moves
seen in the last 10 to 20 years

33. RYM Finanskonsult AB
Credit Risk Measurement

34. RYM Finanskonsult AB
Credit VaR
• Can be defined analogously to
Market Risk VaR
• A one year credit VaR with a 99.9%
confidence is the loss level that we
are 99.9% confident will not be
exceeded over one year

35. RYM Finanskonsult AB
•Capital allocation
•Strategic Decision-Making
•Support for control environment
•Enhancement of risk finance and
•Insurance programs
•New business
Objectives of Operational Risk
Capital

36. RYM Finanskonsult AB
Histogram, Frequency of events
Frequency
-∞Severity
(log scale)
0+∞
Internal
data
External data from
Peer companies
SAS Institute
“Public” data
(20 Years)
Loss data
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
0 500 1 000 1 500 2 000 2 500 3 000 3 500 4 000 4 500 5 000
Severity, MSEK
Probability
Choice for data modelling the
99.9th percentile

37. RYM Finanskonsult AB
Risk Adjusted Performance
Measurements
Profit and Loss
Risk adjusted Capital
= R A P M
How to transform our Risk Measurements into
Capital?

38. RYM Finanskonsult AB
Market Risk Capital
VaR Capital
Multiplier
Economic
Capital* =
Adjustment
Factor *
A result from back
testing is a calibration of
VaR to observed P&L
• Convert from daily to annual horizon
Calculated by a simulation model:
• Management intervention
• Solvency standard

39. RYM Finanskonsult AB
Capital Asset Pricing Model
The formula also calculates the assets sensitivity for non-
diversifiable market risk (Beta-value)
Determines the expected rate of return (Er) of an asset if it is
to be added on an already well-diversified portfolio, given the
assets non-diversifiable risk. It’s a model for pricing a singular
asset or a portfolio
Government
Long Bond Beta Value
Risk Premium
)( fmf rrrCoE = Er
-+= b
CoE = Cost of Equity

40. RYM Finanskonsult AB
The Weighted Average Cost of Capital
WACC
• We can use the individual costs of capital
that we have computed to get our
“average” cost of capital for the firm.
• This “average” is the required return on our
assets, based on the market’s perception of
the risk of those assets
• The weights are determined by how much
of each type of financing we use

41. RYM Finanskonsult AB
Managing Operational risk
• Inadequate Information
systems and technology
• Non-compliance with
Laws and regulations
• Fraud and illegal acts
from Management and
staff
• Weak internal controls
• Environmental factors
• Reputation
• Suppliers failure
• Natural disasters
• Criminal acts
The risk that the following conditions or
events result in losses or reduced confidence
for the company:

42. RYM Finanskonsult AB
Fraud
Société
Genérale
Business-
Interruption
Litigation
Nat West
LTCM
Reputation
Loss
Barings
bank
Settlement
Losses
Supplier
Failure
Mispriced
Portfolios
Ineffective
Procedures
Examples of Operational Threats

43. RYM Finanskonsult AB
Tools for identifying and
managing operational risks
• Self assessments
• Operational risk self assessment
• Rogue trading self assessment
• Incident management
• Key risk indicators
• New product approval procedure
• Business process analysis
• Audit findings
• Business continuity planning
• Employee attitude study
• Operational risk management information system

44. RYM Finanskonsult AB
Handling of operational risks
from a management perspective
• Build a culture in the organisation that promote
operational risk management
• Make operational risk management a natural part
of the business plan
• Focus on findings from tools used
• Take action on identified risks
• Yearly assessment and internal rating of units
• Operational Development Processes (ODP)
• “Governance” project

45. RYM Finanskonsult AB
Driving a culture of operational
risk into the business
• Management commitment
• Common framework
• Usage of common tools for identifying risks
• Involvement and education of all staff
• open minded attitude
• promote reporting
• Show benefits for the organisation – “What’s in it for
me”
• Action plans and follow up

46. RYM Finanskonsult AB
Lessons from Leeson