On Risk in the Capital Markets

One term that people throw around a lot is risk (“I get paid to take risk.” “That risk is priced in.” “What’s the risk in this trade if rates move 100bps?”). The real question about how institutions view risk is very interesting. Let us, for a second, think about one trade that worked out well for a risk-seeking investment bank and what it tells you.

The first thing that I noticed is an issue that (during the writing of this post as a matter of fact) has gotten a lot of play. The senior people at the firm are very involved with the risk decisions. interestingly, this is the second article where I have seen this particular risk-seeking inestment bank’s C.F.O. as the arbiter of risk decisions and as the gatekeeper to committing the firm’s capital–the first was here. One might ask, “What else would a C.F.O. do?” Well, judging the risk and capital positions of the firm is one thing–this is obviously a big job. One has to understand the liquidity and capital needs of the various businesses (does this business churn their balance sheet, how do we have to categorize the positions of this business [Level 3 Assets? Bank positions in a non–mark-to-market book?], where can we reduce balance sheet and capital usage if needed without causing financial losses, etc.). The capital structure of the firm is usually managed under this post (given the interest rate and credit environment whether a firm should issue convertible debt, preferreds, common stock, or bonds if it’s looking to raise capital in the most efficient way possible? I don’t…). To have the C.F.O. calling together senior managers and advocating a position for the firm, that seems odd and interesting at the same time.

Another interesting note is how the senior executives knew the risk positions. For an illiquid product like the ABX, to have enough data for the VaR calculations to be meaningful AND the systems and infrastructure in place for a senior executives to know on such a granular level, pro-actively, hos much risk a desk has on the books shows a long-sighted investment. Let me explain how an assessment of risk occurs at firms that have made less of an investment in their risk organizations. As a matter of fact, I’ve seen this fire drill myself several times. First, someone very senior asks a simple and usually very odd question, like, “What is our exposure to [real estate/leveraged loans/CDOs/commodities]?” This question is the managerial equivalent of a parent asking, “How are you doing in Math, son?” If this parent were helping their child with their homework and was involved day-to-day, even in a very minor way, the answer would be both brief and specific, essentially a delta from the prior answer. If this is the kind of asset class listed above all kinds of people scramble to put together a long PowerPoint presentation that answers the question. Putting together this presentation takes days, if not a week or more. It is then several days if not MUCH longer before the presentation is actually delivered to whichever senior manager requested it. Now, read the difference in that and the process implied in the aforementioned article.

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2 Comments on “On Risk in the Capital Markets”


  1. […] comes from 2001! Mr. Viniar, people probably won’t remember (seems like a lifetime ago), but I noted before, was the guy who convened a firm-wide meeting on exposure to the housing markets. The takeaway is […]

  2. quantum probability Says:

    Isn’t it a little unbelievable in the age of computers that senior management doesn’t have a “dashboard” with this kind of info, which they check the way I check my email?


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