__BANK FINANCIAL MANAGEMENT (BFM) __

Unit - 12: Market Risk

Unit - 12: Market Risk

It is simply risk of losses on Balance sheet and Off Balance sheet items basically in investments due to

movement in market prices.

It is risk of adverse deviation of

Market Risk involves the following:

1. Risk Identification

2. Risk Measurement

3. Risk monitoring and control

4. Risk mitigation.

1. Sensitivity

2. Downside potential

1. Basis Point Value

2. Duration method

Example

Face Value of Bond = 100/- Bond maturity = 5 years

Coupon Rate = 6%

Market price of Rs. 92/- gives yield of 8%

With fall in yield from 8% to 7.95%, market price rises to Rs. 92.10

Difference Yield = 0.5%

Difference in Market price = 0.10

BPV = 0.10/0.05 = 2 i.e. 2 basis points.

Face value of the Bond is 1.00 crore, BPV of the bond is Rs. 2000/- (1,00,00,000*.02/100)

Now, if the yield on Bond with BPV 2000 declines by 8 bps, then it will result into profit of Rs. 16000/- (8x2000).

BPV declines as maturity reaches. It will become zero on the date of maturity.

The Duration of the Bond is 3.7 Years. Formula of Calculation of McCauley Duration = ΣPV*T / ΣPV

Modified Duration = Duration / 1+Yield

Approximate % change in price = Modified Duration X Change in Yield

Modified Duration = Duration/ 1+YTM

Duration = Modified Duration x (1+YTM)

= 5 x 1.06 =

Let VaR =x. It means we can lose up to maximum of x value over the next period say week (time horizon).

Confidence level of 99% is taken into consideration.

A bank having 1 day VaR of Rs. 10 crore with 99% confidence level. It means that there is only one chance in 100 that daily loss will be more than 10 crore under normal conditions.

VaR in days in 1 year based on 250 working days = 1 x 250 / 100 == 2.5 days per year.

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