Part Four

Markets and Risk Management

THIS PART APPROACHES THE ASPECTS of markets and risk in a unique bottom-up manner. While much literature exists on markets and risk management in particular, this part focuses on risk management purely from the standpoint of a global corporate and uses the approach that I have taken while advising firms on how to manage their market-related risk.

The tools that treasurers need to understand and work with markets are discussed in this part. I say “work with,” not “protect against,” because markets are not some hydra-headed monster that rises to erode profits although they sometimes seem that way.

I say “work with,” not “benefit from,” because treasurers of global corporates manage balance sheets of running businesses, not hedge funds, and markets for corporate treasurers are large oceans that one cannot always expect to exploit.

I say “work with,” not “beat,” because markets are not competing with anyone. Markets are supreme; they move with their own willpower, like winds. It would be, at best, rational to expect to sail with them as much as possible, but it is not possible to outrun them consistently or even most of the time. Not all of us have the sagacity of that master of risk and markets, Warren Buffett.

Hence, this part provides suggestions on how to work along with markets and meet risk management goals that are defined by the firm. It is important, as many authors have so correctly pointed out, to know the risks that we are trying to manage.

We cover instruments and the basics on how they are priced. Work has been done on the pricing and the instruments by some very wise men, including John Hull, and some wonderful texts cover these topics in detail. Here we do not attempt to go down the same path. What is important is to know how to use these instruments, how to identify risks, and how to strip them apart, how to get payoff profiles, and how to determine whether products meet our criteria or not.

In Part Four, you learn:

• What risk is. Appreciating what risk and its associated elements mean
• Different kinds of risk. Categorisation of the various forms of risk
• Why manage risk. The benefits (and risks!) of managing risk
• Elements of risk management. Depicted through the evolved IMAGE© methodology of risk management
• Factors impacting risk. Why does risk increase or decrease?
• What risk management does to the firm.
• The rationale for managing risk. Looking at the alternatives of risk management and risk reduction

We start by exploring risk management and its various components.