CHP 8

1. INTRO OF RISK:
• Risk is the possibility of something negative happening, especially when it comes
to something that people value, such as health, wealth, or the environment. Risk
can be defined in different ways depending on the context, but here are some
common ways to think about it:
• In finance:
• Risk is the potential for financial loss in an investment. For example, market
conditions can cause the value of an investment to rise or fall. Investors often
seek higher returns to compensate for taking on more risk.
• In general:
• Risk is the uncertainty of the effects of an activity on something people value. For
example, firefighters face the risk of fire and building collapse while working.
• In management:
• Risk is the possibility of disturbances that could negatively impact a system's
balance and security. Risk can be quantified in terms of costs, damage, or safety.
• Risk management is the process of identifying and mitigating risks
• All investments involve some degree of risk.
• Every saving and investment product has different risks and returns. Differences
include: how readily investors can get their money when they need it, how fast
their money will grow, and how safe their money will be.
• Risk management is intentionally proactive, not reactive.
• Different situations and events can simultaneously result in both good and bad
consequences. Each consequence may require a different risk management
strategy.
• risk management improves financial management
• Banks and other financial services organizations that do not manage risk
effectively are at risk of failing. And, due to their size and interconnectedness,
when a large bank fails, it can lead to negative consequences experienced at a
global level.
• Risks can be of different types, ranging from business risk, financial risk, personal
risk, health risks, and many others. Companies use various techniques to identify
risks and then plan to eliminate or mitigate them.

DEFINITION:
Risk is defined in financial terms as the chance that an outcome or investment's
actual gains will differ from an expected outcome or return. Risk includes the
possibility of losing some or all of an original investment.
MEANING: (TXTBK) & TYPES OF RISK (TXTBK)
2. RISK MANAGEMENT:
INTRO:
• Risk management is a process that helps identify, evaluate, and reduce risks to an
organization.
• Risk management is a proactive process that involves analyzing threats
• Risks are constantly changing, so they need to be tracked over time
• Risk management processes and tools make difficult business and financial
problems easier to address in an uncertain world.
• Risk is not just a matter of fate; it is something that organizations can actively
manage with their decisions, within a risk management framework.
• Risk is an integral part of the business or investment process. Even in the earliest
models of modern portfolio theory, such as .
• Proper identification and measurement of risk, and keeping risks aligned with the
goals of the enterprise, are key factors in managing businesses and investments.
• Good risk management results in a higher chance of a preferred outcome—more
value for the company or portfolio or more utility for the individual.
• Portfolio managers need to be familiar with risk management not only to
improve the portfolio’s risk–return outcome, but also because of two other ways
in which they use risk management at an enterprise level.
• they help to manage their own companies that have their own enterprise risk
issues.
• Second, many portfolio assets are claims on companies that have risks. Portfolio
managers need to evaluate the companies’ risks and how those companies are
addressing them.
• The concept of risk management is also relevant to individuals.
• If a business sets up risk management as a disciplined and continuous process
for the purpose of identifying and resolving risks, then the risk management
structures can be used to support other risk mitigation systems.
• They include planning, organization, cost control, and budgeting.
• In such a case, the business will not usually experience many surprises, because
the focus is on proactive risk management.
• Risk management is an important process because it empowers a business with
the necessary tools so that it can adequately identify and deal with potential
risks.
• risk management provides a business with a basis upon which it can undertake
sound decision-making. Risk identification mainly involves brainstorming. A
business gathers its employees together so that they can review all the various
sources of risk.
 DEFINITION: Risk management is the process of identifying, assessing and
controlling financial, legal, strategic and security risks to an organization’s capital
and earnings.
3. MARGIN:
INTRO:
• Margin is the amount of equity that an investor has in their brokerage account.
• "To buy on margin" refers to buying securities with money borrowed from a
broker.
• To do so, you need a margin account rather than a regular brokerage account. In
a margin account, the broker lends the investor money to purchase more
securities than they could have otherwise with their account balance.
• Margin can be defined as the difference between the amount borrowed from
the brokerage firm and the total value of the assets the investor holds in their
investment account.
• the broker acts as the lender; the investor acts as the borrower and must prove
collateral for the loan in the form of cash deposits and purchase securities.
• Customers earn a return on the invested capital if the purchased securities
appreciate in value.
• In accounting, the margin is used to refer to the profit generated from a sale after
accounting for costs.
• margin represents the difference between the funds borrowed from the lender
and the value of the collateral provided as security for the loan.
TYPES OF MARGIN (TXTBK)

4. SPAN MARGIN:
• Span margin, or Standard Portfolio Analysis of Risk (SPAN), is the minimum
amount of money an investor needs to keep in their account to buy and sell
futures and options (F&O) contracts.

• SPAN margin is calculated using algorithms that consider a range of

factors, including strike prices, interest rates, price changes, volatility,
and time to expiration
• SPAN margin is not fixed and can change based on market conditions
and the risks associated with a particular security.
• SPAN margin is used to determine the minimum margin requirement for an F&O
trade order.
• When an individual is buying or selling any futures or options, their broker
collects something known as Margin
• .there are two broad types of margins: The SPAN margin and exposure margin.
Span and exposure margins are both tools of risk analysis.
 • SPAN margins vary from security to security depending on the nature of risk that
one has to take on along with the security.
• It helps to cover the possibility of the worst price movement of the underlying
stock
• The span margin is also known as the VaR margin in Indian stock markets
• The span margin for a security is never fixed. It can change from time to time
depending upon the current market conditions.

5. METHOD OF CALCULATING VAR:

- Variance-Covariance Method

Also known as the parametric method, this method assumes that the returns generated
from a given portfolio are distributed normally and can be described by standard
deviation and expected returns completely.

The Value at Risk formula:

VaR = Market Price * Volatility

Here, volatility is used to signify a multiple of standard deviation (SD) on a particular

confidence level. Therefore, a 95% confidence will show volatility of 1.65 to the standard
deviation.

#2 - Monte Carlo Simulation

This method uses a non-linear pricing model, and the quantum of risk is measured by
forecasting different future scenarios in this method. This method is best suited in
situations where many risk measurement problems are prevalent. It also provides a
complete and detailed distribution of the portfolio's losses and gains, which might or might
not be symmetrical. However, it is more time-consuming in comparison with other
methods of calculation.

#3 - Historical Method

The investor or the analyst provides a start and an end date called, which elicits a variety of
scenarios that show the historical value at risk. Here the variable is the security's price with
the volatility in the market.

This method computes linear and non-linear possibilities accurately while also displaying
the complete picture of the potential profits and losses in the portfolio.

The formula is as follows:

VaR Formula = vm (vi/ V(i-1))

Here,

M signifies the days in the historical data taken into consideration

Vi indicates the number of variables on the day in question (the day i

6. CROSS MARGIN: (TXTBK)

INTRO:
• Cross margin is a trading strategy that allows traders to use their entire account
balance as collateral for their open positions. It was introduced in the late 1980s
to help traders manage their portfolios and reduce systematic risk.
• Cross margin allows traders to use excess margin from one account to satisfy the
maintenance margin requirements of another. This allows traders to use all
available margin across their accounts.

• Cross margin allows traders to open larger positions with a smaller initial
investment, which can amplify potential profits. It also allows trades to
remain open for longer periods of time.
• Cross margin involves margin that is shared between open positions.
FEATURES:

• Reduced initial margin requirements: Cross margining allows traders to use excess
margin from one account to meet the margin requirements of another. This reduces the
initial margin required for each position.
• Risk management: Cross margining helps traders manage their portfolios by calculating
the overall risk of their portfolio across multiple positions.
• Portfolio flexibility: Cross margining allows traders to move open positions in their
portfolio more freely.
• Available across segments: Cross margining is available across both cash and derivatives
segments.
• Applicable to all market participants: Cross margining is available to all categories of
market participants.