Advanced Structured Financial Products.Продвинутые структурные финансовые продукты.
Views on Structured Financial Products:
Structured products are synthetic investment instruments specially created to meet the needs that cannot be met from the cash financial instruments available in the markets. Structured products can be used: as an alternative to a direct investment; as part of the asset allocation process to reduce risk exposure of a portfolio; or to utilize the current market trend.
Example: Collateralized debt obligations (CDOs) are a type of structured asset-backed security (ABS) with multiple "tranches" that are issued by special purpose entities and collateralized by debt obligations including bonds and loans. Each tranche offers a varying degree of risk and return so as to meet investor demand. CDOs' value and payments are derived from a portfolio of fixed-income underlying assets. CDO securities are split into different risk classes, or tranches, whereby "senior" tranches are considered the safest securities. Interest and principal payments are made in order of seniority, so that junior tranches offer higher coupon payments (and interest rates) or lower prices to compensate for additional default risk. CDOs are unique in that they represent different types of debt and credit risk.
Structured product, also known as a market linked investment, is generally a pre-packaged investment strategy based on derivatives.
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Benefits of structured products:
principal protection (depending on the type of structured product)
tax-efficient access to fully taxable investments
enhanced returns within an investment (depending on the type of structured product)
reduced volatility (or risk) within an investment (depending on the type of structured product)
the ability to earn a positive return in low yield or flat equity market environments
Disadvantages of structured products:
credit risk - structured products are unsecured debt from investment banks
lack of liquidity - structured products rarely trade after issuance and anyone looking to sell a structured product before maturity should expect to sell it at a significant discount
no daily pricing - structured products are priced on a matrix, not net-asset-value. Matrix pricing is essentially a best-guess approach
highly complex - the complexity of the return calculations means few truly understand how the structured product will perform relative to simply owning the underlying asset
Structured products are by nature not homogeneous!
Financial Risk Forecasting Techniques. Методы прогнозирования финансовых рисков.
On a very general level, financial risk could be defined as ‘‘the chance of losing part or all of an investment’’. The task of forecasting financial risk is further complicated by the fact that financial risk cannot be measured directly, but has to be inferred from the behavior of observed market prices. This means financial risk cannot be measured in the same manner as temperature is measured by a thermometer: risk is a latent variable. Volatility, or the standard deviation of returns, is the main measure of risk in most financial analysis. It is sufficient as a risk measure only when financial returns are normally distributed.
Simple volatility models. The most obvious and easy way to forecast volatility is simply to calculate the sample standard error from a sample of returns. Over time, we would keep the sample size constant, and every day add the newest return to the sample and drop the oldest. This method is called the moving average (MA) model. Since the MA model is known to perform badly, it can be improved by exponentially weighing returns, so that the most recent returns have the biggest weight in forecasting volatility. The best known such model is the exponentially weighted moving average (EWMA) model.
The majority of volatility forecast models in regular use belong to the GARCH family of models. The GARCH family of models belong to the category of conditional volatility models and are based on using optimal exponential weighting of historical returns to obtain a volatility forecast. Returns on day t are a function of returns on previous days, where older returns have a lower weight than more recent returns. The parameters of the model are typically estimated with maximum likelihood.
The most common risk measure after volatility is value-at-risk (VaR). It is a single summary statistical measure of risk, it is distribution independent and it is a measure of losses as a result of ‘‘typical’’ market movements.
In general, it is a statistical technique used to measure and quantify the level of financial risk within a firm or investment portfolio over a specific time frame. Value at risk is used by risk managers in order to measure and control the level of risk which the firm undertakes. The risk manager's job is to ensure that risks are not taken beyond the level at which the firm can absorb the losses of a probable worst outcome.
Value at Risk is measured in three variables: the amount of potential loss, the probability of that amount of loss, and the time frame. For example, a financial firm may determine that it has a 5% one month value at risk of $100 million. This means that there is a 5% chance that the firm could lose more than $100 million in any given month. Therefore, a $100 million loss should be expected to occur once every 20 months.
RAROC. In financial analysis, riskier projects and investments must be evaluated differently from their riskless counterparts. By discounting risky cash flows against less risky cash flows, RAROC accounts for changes in the profile of the investment. In general, the higher the risk, the higher the return.
An adjustment to the return on an investment that accounts for the element of risk. Risk-adjusted return on capital (RAROC) gives decision makers the ability to compare the returns on several different projects with varying risk levels.
RAROC=(revenue – expenses - expected loss + income from capital)/capital, where
Income from capital = (capital charges)*(risk-free rate)
Expected loss = average anticipated loss over the measurement period