Derivatives question for banks - Please assist

[free_money]

Hi to all,

I have 2 Questions which I hope someone can help me out:

1) What is the main derivatives market that banking institutions use? (Is OTC)

2) Summarise (and if possible asses) how a bank would use derivatives to manage risk.

I hope I can get some positive feedback from intelligent individuals.

Thank you very much!!!

 

[gooseman]

gonna have to narrow that down mate

 

[philhackett]

Hi to all,

I have 2 Questions which I hope someone can help me out:

1) What is the main derivatives market that banking institutions use? (Is OTC)

2) Summarise (and if possible asses) how a bank would use derivatives to manage risk.

I hope I can get some positive feedback from intelligent individuals.

Thank you very much!!!

The most effective way of assessing risk is to establish how much insuarbnce will cost to protect your position; currentlu about 100% of the cost 12 months ago.

Better to trade ETF's, especialy Bullion and Oil in anticipation of the event that Colin Powell has warned about on 21/22 January.

 

[free_money]

Thank you very much for your responses. Sorry for my lack of knowledge on the subject, even though I have read a lot on the literature. I find it difficult to get to grips with.
I would like to know two questions;

What is the main (financial) derivatives markets that banks use to manage their exposure to risk?

and

How do they use this market to manage their risk. I.e. do they use puts, options, cfd's??

Thank you all for helping, I hope these questions can get answered briefly so that I can do further reading after.

 

[free_money]

GJ thanks for that. I know it is very brief but do they use puts and calls or do they use totally different instruments. Linear risk is difficult in practice (so I have read) but does this risk comprise of all total risk (ie. mortgages, credit cards, interest rates, saving accounts, shares etc.) or in particular risk.
How do they actually use financial derivatives to hedge (or manage) their risk

 

[MrGecko]

do your homework

Options, Futures, and Other Derivatives (Prentice Hall Series in Finance): JOHN C HULL: Amazon.co.uk: Books

 

[Hoggums]

Well done for GJ trying to help. Your questions are so vague and demonstrate a complete lack of knowledge it's difficult to know how to help.

Simplistically - a bank will hedge a net position using either the underlying or a derivative. E.g. A very simple hedging server I worked on a while back bought/sold the opposite of the net client FX positions and combined this with simple delta hedging on their FX option positions. (It broke down one day and netted the bank a few hundred thousand - but that's another story).

Derivatives aren't necessarily used for hedging. However a simple example of using an option for hedging would be to buy an out of money put option on a share you own. Thus if the share price crashes your put option provides some insurance (at a premium).

 

[A Dashing Blade]

Hi to all,

I have 2 Questions which I hope someone can help me out:
. . .
Thank you very much!!!

Lazy student in "essay due in today" shock horror!

 

[free_money]

A Dashing Blade, what is it with the 'judgements' I am asking a question, if you can't answer it then fair enough. But do not come out with stupid assumptions - 'lazy' - NO MATE, 'student' - yes about 7 years ago, 'essay due in today' - what are you on about.

Back to the question, I appreciate the help and I know there is many instruments in hedging and speculation. But what is banks most primary tool in derivatives, when managing risk. The risk could be interest rate, exchange rates. Do they adapt the use of SWAPS, options - calls and puts, forwards/futures.
Do they use continuous time option pricing models?

What are common methods/practices?

Thank you to all, who are willing to help.

 

[gooseman]

depends where their risk lies. if their risk is interest rates as a result of an OTC swap they might trade some futures or an option. they can use FRA's, exotics, anything. still too vague.

if tyou want to ask a direct question ask it.

here is a small example-a large corporate calls an i-bank and says I am expecting monthly payments for a loan agreed at x% but i am receiving USD and I am a GBP based compnay. so they have FX and interets rtae risk. they can execute an OTC swap with the bank to receive a fixed rate in GBP and the bank will take on the IR and FX risk from the person paying the corporate. They will have charged a price for this transaction in basis points and they will hedge their risk in the market with a future, or forward, or an option probably on the exchange locking in a profit. Or they may partial hedge it if they have a view on the FX rate or interets rate.

 

[MrGecko]

look mate - don't take any offence, but the silliness of the answers you are getting is reflected in the questions you ask.

"when managing risk" is about as useful as a chocolate teapot - it's like saying "which is the best way to fish?" - you mean commercial fishing? deep water? Fresh water? Fly fishing? which type of fish? what do you want to do with them?

better questions will yield better results.

 

[raysor]

look mate - don't take any offence, but the silliness of the answers you are getting is reflected in the questions you ask.

"when managing risk" is about as useful as a chocolate teapot - it's like saying "which is the best way to fish?" - you mean commercial fishing? deep water? Fresh water? Fly fishing? which type of fish? what do you want to do with them?

better questions will yield better results.

LOL!! If you don't know the question it is very difficult to get the answer.

The state the banks are in the answer seems like NONE!

 

[arabianights]

They hedged the risks they had identified very well

 

[free_money]

Thanks for the help people, really do appreciate it, but it seems that I am far too vague.

When I get the answers I am looking for I will post them up, while then feel free to add any suggestions/pointers.

Thank you all!

 

[tripleogstar]

Thanks for the help people, really do appreciate it, but it seems that I am far too vague.

When I get the answers I am looking for I will post them up, while then feel free to add any suggestions/pointers.

Thank you all!

Basically, the derivative you use to manage risk depends on what market you are operating in. If you are working on a gilts desk ( that is a UK Government bond desk) you would use the Long Gilt FUTURES contract to hedge your positions in the cash market. To put it in terms you mite understand, a trader working for an investment bank is likely to be a market maker and therefore has to buy and sell. So if a trader has to buy a bond he doesnt want, he can limit his risk (the chance of the bond price falling) by going SHORT on gilt futures contract (going short means selling, betting that the price of gilts will fall). So a his loss on the actual bond will be limited by the gain in the
futures contract. Similarly, If you are a stock trader you could use options to hedge.
So banks do use derivatives to hedge, it is an essential tool for a market maker.
I hope this answers your question to some extent, if it doesnt, then I guess i don't know what the hell you r on about

 

[free_money]

Thanks for the Tripleogstar.

 

[Bowball]

sorry if this has been covered before. I'm an ex IB derivatives dealer (sales side)

OTC = Over The Counter. basically means any product (deriv, bond, equity, whatever) that isnt traded through an exchange. FTSE 100 stocks trade on the London Stock Exchange (LSE), FX Options trade OTC because they are bought and sold directly between banks (or individuals) on the interbank market. there are reasons why some products trade OTC vs exchange which are usually down to history. also, trading OTC you assume the credit risk of the counterparty you trade with.

how do banks manage risk? same as you and i do. they use swaps to hedge interest rate risk. fx forwards to hedge future fx risk. etc etc etc. remember that derivs were invented to reduce risk rather than speculation

 

[free_money]

Thank you very much for that Bowball, that has really cleared things up!