RISK MANAGEMENT IN STOCK EXCHANGES

Tapas Das

WHAT IS RISK ?

Uncertainty. An event may or may not happen. Types of Risk?

TYPES OF RISK

Credit Risk / Counterparty Risk Price Risk Liquidity Risk

CREDIT RISK
Lending Risk Direct Lending Contingent Counterparty Presettlement Settlement Issuer Clearing

: Loans/Credit cards/Mortgages : Letter of Credit / Guarantees

: Underwriting & Issuer activities

MARKET RISK
Price Interest rates Commodity Prices Volatility in Options Liquidity Funding liquidity Trading Liquidity

OTHER RISKS
Equity Country or Sovereign Political Convertibility (Cross Border) Transfer Fiduciary Documentation Disclosure Legal and Regulatory Systems

RISK MANAGEMENT
Financial soundness - Capital adequacy requirements Structured system of Margining Daily Price Bands on Securities On line position monitoring systems Offline Surveillance activity Settlement Guarantee Fund

RISK MANAGEMENT- CAPITAL ADEQUACY REQUIREMENTS

Cash Component Cash Bank FDR Bank Guarantees Govt. Securities Non Cash Component Approved Securities

RISK MANAGEMENT STRUCTURED SYSTEM OF MARGINING

Types
Value at Risk Margin Extreme Loss Margin Mark to Market margin

Margining at Client level (Gross level) Margins can be paid in any form of eligible collateral

Cash Fixed deposit receipts Bank guarantees Government securities and Securities

RISK MANAGEMENT: PRICE BANDS & FREEZES

Price bands of 20% (either way) Quantity Freeze Pre-open trades for price discovery.

RISK MANAGEMENT - ON LINE POSITION MONITORING SYSTEM

On-line Alert to members Notification at 70%, 85%, 90% , 95% and 100% Separate Bands for Initial Margins & Exposure Limits Automatic disablement

RISK MANAGEMENT ONLINE & OFFLINE SURVEILLANCE

Online Surveillance
Traded price > than certain % of Last traded Price Intra-day high low variation beyond threshold Large order compared with floating stock of the company Securities trading close to or hitting price band

Offline Surveillance

Plot of price/volume charts and analyze crests & troughs Determine the participants during the shortlisted period Building time sequence programs (patterns) to ascertain manipulation.

SPECIFIC TO F&O

F&O RISK MANAGEMENT

Real time Upfront portfolio based margins Based on 99% VaR Client level monitoring Revision of parameters 6 times

LIQUID ASSETS

Comprises of Cash and Non Cash Ratio of 50:50 to be maintained Minimum liquid Net Worth Rs.50 lacs

INITIAL MARGINS
OBJECTIVE : TO IDENTIFY OVERALL RISK IN A PORTFOLIO
Margins calculated using SPAN ( CME ) 16 possible scenarios computed using variations in price and volatility Calculates maximum probable loss based on above scenarios Buy premium and assignment margin also form part of initial margin

FACTORS AFFECTING VALUE OF AN OPTION

Underlying market price Strike Price Volatility of the underlying instrument Time to expiry Interest Rate

PREMIUM MARGINS
To be paid by a buyer of an option Till the premium settlement is complete

ASSIGNMENT MARGINS

To be paid on assigned positions Both for Interim and Final Exercise Settlement
Till such obligations are fulfilled levied at Clearing Member level

EXPOSURE MARGIN
Exposure Limits Options : Only short positions Futures : For both long and short positions

Applicable rates Index Futures / Options : 3% of notional value for open positions Stock Futures / Options : 5% or 1.5 of notional value for open positions
Notional value Futures : Contract price Options: Closing price of the security on the cash segment on the previous day

SETTLEMENT GUARANTEE FUND THE LAST MAN STANDING

Final
CH Cap 5th Line of Defence

SGF of other s
4th Line of Defence

Insurance
3rd Line of Defence

Interest on SGF /Profit of current year

2nd Line of Defence

Membership Deposit
1st Line of Defence

Margin of defaulting member Variation/Intraday/Initial