This page contains a Flash digital edition of a book.
Hedging Decisions
Table2: HedgeAdvisoryDashboard.ImpactofQ22009HedgeAlternatives
Physical 25%With 50%With 75%With ZeroCost Call
KRI(1Quarter,99%Level) Exposure Swaps Swaps Swaps Collars Options
CostatRisk&StressTests
••• •••
PotentialFutureExposure
• • ••
Margin/CollateralatRisk
••• • • •
PotentialRatingDowngrade
• ••••
PotentialRegret
••••• •
HedgeIneffectiveness
• •
DollarHedgingCosts
•••• •
Source: NquantX, LLC •
= High

= Medium

= Low
FourStepstoMakeHedgingDecisionsforBoards risk’ metrics to measure and manage risks, and more on
Four simple questions can assist boards in proactive identification, communication and mitigation of
formulating their hedging policy: large losses under extreme market events. An innovative tool
to identify material risks is the ‘reverse stress test’ which
1. What are the material risks that can consists of identifying the events that could threaten the
affect the business goals? survival of the firm and explain to stakeholders what is being
done to protect the firm against those events.
Boardsneedinformationonthematerialrisksthatcanhavea
impact on the business goals of the firm. For example, the board 3. What risks if left unhedged threaten the
could determine a materiality threshold to determine the impact viability of the firm?
onkeymetricssuchasearningsandcashflowwhenariskshould
be explicitly managed in a more methodical fashion. Some firms have a hedging philosophy that determines the
framework to make hedging decisions. For example, one of the
2. What is the natural risk profile of the firm in guiding principles of a hedging policy should be to
the event of an inaction decision not to hedge? unambiguously determine how management should deal with
those risks that lie outside the board’s risk tolerance and how
For those material risks, boards should demand information they could threaten the viability of the firm if left unhedged. If
related to the current natural offsets within the firm before a particular outcome is deadly to the firm and is relatively easy
considering hedging individual risks to avoid over hedging. to insure, even if it appears unlikely to occur, the firm should
That will also help management determine whether the firm hedge anyway. The cost of insuring against what appears to be
should consider hedging some of the residual risks. Simulation extreme outcomes is usually quite small if the decision is made
tools can provide insights into the potential outcomes on key before the event takes place.
performance metrics of a given strategy, including inaction.
The implementation of robust model risk assessment 4. What is the risk and value tradeoff
techniques, based on realistic assumptions about short and of alternative strategies?
long-termmarketdynamics(particularlythe‘heavy’tailsofthe
distributions) allows firms to incorporate credit and liquidity Before a hedging decision is made, the main strategies
considerations as well as the risk taker’s response to various should be evaluated in the right context. Misalignment in the
marketevents.Market,credit,margin,accountingandliquidity perception of the main goals and lack of a common language
risks can be analysed in an integrated dynamic simulation to evaluate the risks behind various alternative hedging
framework. In order to obtain a comprehensive view of risk strategies often result in inaction or rushed decisions.
across the enterprise, the strategic, reputation and business For boards to make an informed and coherent decision
risks must also be quantified and included in the risk analysis. regarding the desired risk profile of the firm, they need the
In the future, we believe there will be less emphasis on ‘at- right information regarding the risk-return tradeoffs of a pre-
46 worldPower2009
Page 1  |  Page 2  |  Page 3  |  Page 4  |  Page 5  |  Page 6  |  Page 7  |  Page 8  |  Page 9  |  Page 10  |  Page 11  |  Page 12  |  Page 13  |  Page 14  |  Page 15  |  Page 16  |  Page 17  |  Page 18  |  Page 19  |  Page 20  |  Page 21  |  Page 22  |  Page 23  |  Page 24  |  Page 25  |  Page 26  |  Page 27  |  Page 28  |  Page 29  |  Page 30  |  Page 31  |  Page 32  |  Page 33  |  Page 34  |  Page 35  |  Page 36  |  Page 37  |  Page 38  |  Page 39  |  Page 40  |  Page 41  |  Page 42  |  Page 43  |  Page 44  |  Page 45  |  Page 46  |  Page 47  |  Page 48  |  Page 49  |  Page 50  |  Page 51  |  Page 52  |  Page 53  |  Page 54  |  Page 55  |  Page 56  |  Page 57  |  Page 58  |  Page 59  |  Page 60  |  Page 61  |  Page 62  |  Page 63  |  Page 64  |  Page 65  |  Page 66  |  Page 67  |  Page 68  |  Page 69  |  Page 70  |  Page 71  |  Page 72  |  Page 73  |  Page 74  |  Page 75  |  Page 76  |  Page 77  |  Page 78  |  Page 79  |  Page 80  |  Page 81  |  Page 82  |  Page 83  |  Page 84  |  Page 85  |  Page 86  |  Page 87  |  Page 88  |  Page 89  |  Page 90  |  Page 91  |  Page 92  |  Page 93  |  Page 94  |  Page 95  |  Page 96  |  Page 97  |  Page 98  |  Page 99  |  Page 100  |  Page 101  |  Page 102  |  Page 103  |  Page 104  |  Page 105  |  Page 106  |  Page 107  |  Page 108  |  Page 109  |  Page 110  |  Page 111  |  Page 112  |  Page 113  |  Page 114  |  Page 115  |  Page 116  |  Page 117  |  Page 118  |  Page 119  |  Page 120  |  Page 121  |  Page 122  |  Page 123  |  Page 124  |  Page 125  |  Page 126  |  Page 127  |  Page 128  |  Page 129  |  Page 130  |  Page 131  |  Page 132  |  Page 133  |  Page 134  |  Page 135  |  Page 136  |  Page 137  |  Page 138  |  Page 139  |  Page 140  |  Page 141  |  Page 142  |  Page 143  |  Page 144  |  Page 145  |  Page 146  |  Page 147  |  Page 148  |  Page 149  |  Page 150  |  Page 151  |  Page 152  |  Page 153  |  Page 154  |  Page 155  |  Page 156  |  Page 157  |  Page 158  |  Page 159  |  Page 160  |  Page 161  |  Page 162  |  Page 163  |  Page 164
Produced with Yudu - www.yudu.com