Prof. Ian Giddy New York University Structured Finance: Synthetic ABS.
Treasury Control and Performance Evaluation Prof Ian Giddy New York University.
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Transcript of Treasury Control and Performance Evaluation Prof Ian Giddy New York University.
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 3
A Corporate Foreign Exchange Application
TRANSACTIONS
FORECASTS FROM
BUSINESS UNITSCONSOLIDATION
NET POSITIONS,
BY CURRENCY
AND MATURITYVOLATILITY AND
CORRELATION
FORECASTS
VALUE
AT
RISK
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 4
FIRM'S INT'LBUSINESS
BOOKED &ANTICIPATED
TRANSACTIONS
REPORTINGSYSTEM
SCHEDULE OFFX FLOWS
PORTFOLIOANALYSIS OF
FX EXPOSURE
NETEXPOSURESIN FOREIGN
CURRENCIES
MEASUREMENTOF FX RISK BY
CURRENCY
RISKMANAGEMENT
DECISIONS
CORRELATIONDATA
VOLATILITYDATA
HEDGINGTRANSACTIONS
The VaR Management Cycle
This process can be undertaken on a monthly cycle basis, as the institution revises its estimates of future business and as new data on volatilities and correlations are acquired.
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 5
FIRM'S INT'LBUSINESS
BOOKED &ANTICIPATED
TRANSACTIONS
REPORTINGSYSTEM
SCHEDULE OFFX FLOWS
PORTFOLIOANALYSIS OF
FX EXPOSURE
NETEXPOSURESIN FOREIGN
CURRENCIES
MEASUREMENTOF FX RISK BY
CURRENCY
RISKMANAGEMENT
DECISIONS
CORRELATIONDATA
VOLATILITYDATA
HEDGINGTRANSACTIONS
The VaR Management Cycle
PERFORMANCE
EVALUATION
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 6
Performance evaluation: “the science of attribution”
Example: Why did this taxi take so long?The traffic; the driver; my lousy
instructions? How much should I tip this taxi
driver? Would I use this taxi company
again?
Why Measure Performance of Treasury?
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 7
Why Measure Performance of Treasury?
Like banks, treasurers face market risks, and must manage them
Unlike banks, exposures cannot be known with precision - so there’s no such thing as “fully hedged”
Hedging is a dynamic process Making money is not enough - must be
evaluated relative to cost and risk and capital allocated.
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 8
Nokia: “performance measurement (selective vs. full hedge) is encouraged but not required”
Ericsson: “it is something we should look at” Borealis: “no satisfactory relationship between
risk and return” Kværner’s qvestions:
Am I making money and if so, why?How does my profit or loss relate to the
risks that have been taken?
Baltic Benchmarking
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 9
What Do We Want to Measure?
Return performance (did we outperform some benchmark measure?)
Risk reductionHedged positions?Reduced earnings volatility (historical)?Reduced Value at Risk (anticipated)?
Reporting, disclosure and problem identification (have we improved our risk measurement system?)
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 11
Kinds of Trading Risk forPerformance Measurement
Corporate Risk Hedging vs Bank-within-the-Company
What Risks?Position RiskBasis RiskLiquidity RiskCounterparty Risk
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 12
Choosing the Right Yardstick: Return
Profitability - wrong! Compare with “best practice”
companies - wrong. Compare with “forward rates” Evaluate return relative to risk
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 13
TIME
EXCHANGE RATE Spot
Forward
Actual
Probabilitydistributionof actualexchange rate
Today In three
months
Unbiased Forward Rate Theory
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 15
Performance Evaluation: ExampleFARMCO: PERFORMANCE EVALUATIONOct. 1 1995
Predicted exposures Spot Forward
Expected Return Volatility Hedge
CAD -200758 1.3374 1.3405 1.0% 1.79 150000DEM 22365 1.4288 1.4165 2.5% 3.82 0JPY -15688 100.39 97.83 2.0% 3.71 10000Portfolio expected profit 1,180 Portfolio total VaR 9,337 Portfolio diversified VaR 5,210 Expected gain, relative to risk (VaR) 23%April 1 1996
Actual Exposures
Actual Spot
Actual Return
Actual Volatility Hedge
CAD -220400 1.3736 2.5% 2.1 150000DEM 24000 1.3901 1.9% 4.2 0JPY -11500 97.00 -0.8% 5.3 10000Portfolio actual profit 1,278 Portfolio total VaR 11,251 Portfolio diversified VaR 5,913 Actual gain, relative to actual risk (VaR) 22%
Adjusted gain, based on predicted exposures 788 Adjusted gain, relative to actual risk (VaR) 13.3%Adjusted gain, relative to ex-ante risk (VaR) 15.13%
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 16
Performance Evaluation: ExampleFARMCO: PERFORMANCE EVALUATIONOct. 1 1995
Predicted exposures Spot Forward
Expected Return Volatility Hedge
CAD -200758 1.3374 1.3405 1.0% 1.79 150000DEM 22365 1.4288 1.4165 2.5% 3.82 0JPY -15688 100.39 97.83 2.0% 3.71 10000Portfolio expected profit 1,180 Portfolio total VaR 9,337 Portfolio diversified VaR 5,210 Expected gain, relative to risk (VaR) 23%April 1 1996
Actual Exposures
Actual Spot
Actual Return
Actual Volatility Hedge
CAD -220400 1.3736 2.5% 2.1 150000DEM 24000 1.3901 1.9% 4.2 0JPY -11500 97.00 -0.8% 5.3 10000Portfolio actual profit 1,278 Portfolio total VaR 11,251 Portfolio diversified VaR 5,913 Actual gain, relative to actual risk (VaR) 22%
Adjusted gain, based on predicted exposures 788 Adjusted gain, relative to actual risk (VaR) 13.3%Adjusted gain, relative to ex-ante risk (VaR) 15.13%
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 17
What Happened?FARMCO: PERFORMANCE EVALUATIONOct. 1 1995
Predicted exposures Spot Forward
Expected Return Volatility Hedge
CAD -200758 1.3374 1.3405 1.0% 1.79 150000DEM 22365 1.4288 1.4165 2.5% 3.82 0JPY -15688 100.39 97.83 2.0% 3.71 10000Portfolio expected profit 1,180 Portfolio total VaR 9,337 Portfolio diversified VaR 5,210 Expected gain, relative to risk (VaR) 23%April 1 1996
Actual Exposures
Actual Spot
Actual Return
Actual Volatility Hedge
CAD -220400 1.3736 2.5% 2.1 150000DEM 24000 1.3901 1.9% 4.2 0JPY -11500 97.00 -0.8% 5.3 10000Portfolio actual profit 1,278 Portfolio total VaR 11,251 Portfolio diversified VaR 5,913 Actual gain, relative to actual risk (VaR) 22%
Adjusted gain, based on predicted exposures 788 Adjusted gain, relative to actual risk (VaR) 13.3%Adjusted gain, relative to ex-ante risk (VaR) 15.13%
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 18
How Am I Doing?FARMCO: PERFORMANCE EVALUATIONOct. 1 1995
Predicted exposures Spot Forward
Expected Return Volatility Hedge
CAD -200758 1.3374 1.3405 1.0% 1.79 150000DEM 22365 1.4288 1.4165 2.5% 3.82 0JPY -15688 100.39 97.83 2.0% 3.71 10000Portfolio expected profit 1,180 Portfolio total VaR 9,337 Portfolio diversified VaR 5,210 Expected gain, relative to risk (VaR) 23%April 1 1996
Actual Exposures
Actual Spot
Actual Return
Actual Volatility Hedge
CAD -220400 1.3736 2.5% 2.1 150000DEM 24000 1.3901 1.9% 4.2 0JPY -11500 97.00 -0.8% 5.3 10000Portfolio actual profit 1,278 Portfolio total VaR 11,251 Portfolio diversified VaR 5,913 Actual gain, relative to actual risk (VaR) 22%
Adjusted gain, based on predicted exposures 788 Adjusted gain, relative to actual risk (VaR) 13.3%Adjusted gain, relative to ex-ante risk (VaR) 15.13%
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 19
Key Measures of Performance
Return: (Actual return - forward premium) Return relative to risk
(the “Sharpe” ratio):Historical volatility of returnsHistorical volatility of position valueEx ante Value at Risk
RETURN
RISK
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 20
The Sharpe ratio.(actual return relative to actual risk)
The risk ratio.(actual return relative to prospective risk)
The efficiency ratio.(actual risk relative to prospective risk)
Use risk-return performance measures to evaluate individual trader performance.
Using a VaR Measure for Trading-Portfolio Performance Evaluation
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 21
Performance Measurement: Roadmap
FINANCIAL SIDE
OPERATIONAL SIDE
EXPOSURES Known Anticipated
Map exposures
Map risks
Manage risks
Measure performance Take actions to improve
performance
MARKET PRICES
MARKET VOL & CORR.
RISK MEASUREMENT VaR Worst-case scenario, etc.
RISK MANAGEMENT Hedging Investment or trading
PERFORMANCE MEASUREMENT Relative return Relative risk.
INCENTIVES ALLOCATION OF RESOURCES.
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 22
Sola Chemical
A rea T reasurer A rea C ontro ller A rea T ax A ttorney
M anagers ,A s ia
E uropeLatin A m erica
A ssistant Controller Intl
C ontro ller
A ssistant Treasurer Intl
T reasurer Tax A ttorney
F inance C om m ittee
P res identS ola U S A
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 23
Sola Chemical
Tax planning - cerntralize? FX exposure - Paper loss? Centralize to
net exposures? Transfer pricing and performance
evaluation - 2nd set of books? Sourcing funds - cheap local
opportunities lost? Other considerations?
A rea T reasurer A rea C ontro ller A rea Tax A ttorney
M anagers ,A s ia
E uropeLatin A m erica
A ssistant Controller Intl
C ontro ller
A ssistant Treasurer Intl
T reasurer Tax A ttorney
F inance C om m ittee
P res identS ola U S A
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 24
Performance evaluation: “the science of attribution”
Why did we make/lose money?The market; the FX manager; my
lousy instructions? How much should I tip this FX
manager? Would I use this method again? How good is my performance
measurement system?
Treasury Performance Measurement: Conclusion
Copyright ©1996 Ian H. Giddy Management, Markets and Linkages 26
Summary of “Value at Risk” Reporting
“At close of business each day tell me what the market risks are across all businesses and locations.”
Dennis Weatherstone, JP Morgan
Logical steps:Economic-value accounting (need market prices
or models)Market-price based performance measurementVolatilities and correlations of market pricesManagement of riskOptimization of hedging