Page 177 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Derivatives & Risk Management Dilfraz Singh, Lovely Professional University

Notes Unit 13: Risk Management with Derivatives II

CONTENTS
Objectives
Introduction
13.1 Index Options and Futures

13.1.1 Index Options
13.1.2 Index Futures
13.2 VaR

13.3 Historical Simulation
13.4 Risk Management Structure and Policies on India
13.4.1 Risk Governance Structure
13.4.2 Risk Management Policy
13.5 Summary

13.6 Keywords
13.7 Review Questions
13.8 Further Readings

Objectives

After studying this unit, you will be able to:
 Define index options and futures
 Describe VaR and historical simulation
 Discuss risk management structure and policies in India

Introduction

Traditionally used tools for assessing and optimizing market risk assume that the portfolio
return is normally distributed. In this way, the two statistical measures mean and standard
deviation can be used to balance return and risk.
However, often, as in the case of credit losses, the distributions of losses are far from normal;
they are heavily skewed, with a long fat tail. In the case of credit losses, the distribution is a
result of the fact that an obligor rarely defaults or changes credit rating, but when default occurs
losses are generally substantial.

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Caution Value-at-Risk (VaR) is by far the most popular and most accepted risk measure
among financial institutions. VaR is an estimate of the maximum potential loss with a
certain confidence level, which a dealer or an end-user of financial instruments would
experience during a standardized period (e.g. day, week, or year). In other words, with a
certain probability, losses will not exceed VaR.

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