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The IUP Journal of financial Risk Management

December' 06
Focus Areas
  • Identifying financial risk
  • Risk management models
  • Accounting for derivatives
  • Risk-hedging techniques
  • Asset liability management.
Sharpening the Tools of Country Risk Analysis
The Dynamics of the Short-term Interest Rate in the UK
Risk Management of Securitization Transaction: Implications of Basel II
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Sharpening the Tools of Country Risk Analysis

-- Roger Mills, Marcin Peksyk and Bill Weinstein

This paper addresses the challenge of how to express Country Risk. The authors focus on cross-border investment and review several approaches to Country Risk Assessment (CRA), which are placed in the context of the recent accession of many Eastern European countries to the European Union. However the issues and the principles would apply to the other areas of the widening global chess-board. As the creation of a single currency zone eliminates only one kind of Country Risk, the issue of measuring Country Risk in investment appraisals revives the debate as to whether Country Risk should be considered as specific risk and dealt with by adjusting the cash flows, or as a systematic risk and expressed in the additional premium to the discount rate, which is used in determining the cost of capital. The paper proceeds to apply and compare methods of incorporating risk factors into the cost of capital. A Polish example is used to test methods that can be used to estimate a country's equity risk premium. This is then followed by the issues involved in moving from the estimation of Country Risk to project risk, adopting the perspective of an individual company's exposure to risk. The calculations are once again speculatively applied to Poland, and show that different expected returns arise from different approaches. Within the great debate in the financial community as to how, where and when to include Country Risk factors in the project appraisal process, many s build from one point of consensus, namely, that the cost of capital (the discount rate) should reflect only non-diversifiable risk, whereas diversifiable risk is better handled in the cash flows. A key example using Discounted Cash Flow (DCF) for a green field project in Poland is subjected to two parallel analyses, one of which uses scenario analysis and the other a discount rate for Country Risk. Not only do the results significantly diverge, one of them appears contrary to any acceptable version of common sense. The authors therefore conclude that there is no established single correct approach to measuring Country Risk. This paper exhibited the need to interrogate assumptions; it did not purport to provide answers. For the subject of Country Risk, using the EU accession countries as fresh field for research, it is urgent that less ambiguous techniques for measuring risk be rapidly developed.

Article Price : Rs.50

The Dynamics of the Short-term Interest Rate in the UK

-- Antonios Antoniou,
Alejandro Bernales S and Diether W Beuermann

The authors estimated and tested different continuous-time short rate models for the UK. The preferred model encompasses both the `level effect' of Chan, Karolyi, Longstaff and Sanders (1992a) and the conditional heteroskedasticity effect of Generalized Autoregressive Conditional Heteroskedastic (GARCH) type models. The findings suggest that, including a GARCH effect in the specification of the conditional variance, almost halves the dependence of volatility on the rate levels. The paper finds weak evidence of mean-reversion and volatility asymmetries in the stochastic behavior of rates. Extensive diagnostic tests suggest that the Constant Elasticity of Variance model of Cox (1975), with an added GARCH effect, provides a reliable description of short rate dynamics. The authors demonstrate that the most important feature in short rate modeling is the correct specification of the conditional variance of changes in rates, suggesting that the conditional mean characterization is of second order.

Article Price : Rs.50

Liquidity Risk and Contagion

-- Rodrigo Cifuentes,
Gianluigi Ferrucci and Hyun Song Shin

This paper explores liquidity risk in a system of interconnected financial institutions when such institutions are subject to regulatory solvency constraints and mark their assets to market. When the market's demand for illiquid assets is less than perfectly elastic, sales by distressed institutions depress the market prices of such assets. Marking to market of the asset book can induce a further round of endogenously generated sales of assets, depressing prices further and inducing further sales. Contagious failures can result from small shocks. The authors investigate the theoretical basis for contagious failures and quantify them through simulation exercises. Liquidity requirements on institutions can be as effective as capital requirements in forestalling contagious failures.

Risk Management of Securitization Transaction: Implications of Basel II

--Ram Pratap Sinha

The advent of Basel I capital adequacy proposal led to the growth of securitization transactions by making certain assets off-balance sheet. A bank could hold less capital on an overall basis in the Basel I regime. However, this led to an increase in the concentration of credit risk in the books of the concerned financial institutions. This is because commercial banks securitized their best quality loan portfolio and as these items turn off-balance sheet, the overall portfolio riskiness increased substantially. In order to cope with the situation, the Basel II framework dealt with the securitization transactions in a comprehensive manner. This paper attempts to provide a brief overview of the implications of Basel II in respect of securitization transactions.

Article Price : Rs.50


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Automated Teller Machines (ATMs): The Changing Face of Banking in India

Bank Management
Information and communication technology has changed the way in which banks provide services to its customers. These days the customers are able to perform their routine banking transactions without even entering the bank premises. ATM is one such development in recent years, which provides remote banking services all over the world, including India. This paper analyzes the development of this self-service banking in India based on the secondary data.

The Information and Communication Technology (ICT) is playing a very important role in the progress and advancement in almost all walks of life. The deregulated environment has provided an opportunity to restructure the means and methods of delivery of services in many areas, including the banking sector. The ICT has been a focused issue in the past two decades in Indian banking. In fact, ICTs are enabling the banks to change the way in which they are functioning. Improved customer service has become very important for the very survival and growth of banking sector in the reforms era. The technological advancements, deregulations, and intense competition due to the entry of private sector and foreign banks have altered the face of banking from one of mere intermediation to one of provider of quick, efficient and customer-friendly services. With the introduction and adoption of ICT in the banking sector, the customers are fast moving away from the traditional branch banking system to the convenient and comfort of virtual banking. The most important virtual banking services are phone banking, mobile banking, Internet banking and ATM banking. These electronic channels have enhanced the delivery of banking services accurately and efficiently to the customers. The ATMs are an important part of a bank’s alternative channel to reach the customers, to showcase products and services and to create brand awareness. This is reflected in the increase in the number of ATMs all over the world. ATM is one of the most widely used remote banking services all over the world, including India. This paper analyzes the growth of ATMs of different bank groups in India.
International Scenario

If ATMs are largely available over geographically dispersed areas, the benefit from using an ATM will increase as customers will be able to access their bank accounts from any geographic location. This would imply that the value of an ATM network increases with the number of available ATM locations, and the value of a bank network to a customer will be determined in part by the final network size of the banking system. The statistical information on the growth of branches and ATM network in select countries.

Indian Scenario

The financial services industry in India has witnessed a phenomenal growth, diversification and specialization since the initiation of financial sector reforms in 1991. Greater customer orientation is the only way to retain customer loyalty and withstand competition in the liberalized world. In a market-driven strategy of development, customer preference is of paramount importance in any economy. Gone are the days when customers used to come to the doorsteps of banks. Now the banks are required to chase the customers; only those banks which are customercentric and extremely focused on the needs of their clients can succeed in their business today.


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Financial Risk Management