Risk Management

Mistakes to Avoid
Chapter 28

Risk Management and Financial Institutions 4E, Chapter 28, Copyright John C. Hull 2015

Big Losses (Business Snapshot 24.1, page 510)

Allied Irish Bank ($700 million)

Barings ($1 billion)
Enrons Counterparties ($ billions in lawsuits)
Hammersmith and Fulham ($600 million)
Kidder Peabody ($350 million)
LTCM ($4 billion)
National Westminster Bank ($130 million)
Orange County ($2 billion)
Procter and Gamble ($90 million)
Soc Gen ($7 billion)
Subprime Mortgage Losses ($ tens of billions)
UBS (2.3 billion)

Risk Management and Financial Institutions 4E, Chapter 28, Copyright John C. Hull 2015

Risk Limits (page 509-512)

Risk must be quantified and risk limits set
Exceeding risk limits not acceptable even when
profits result
Do not assume that you can outguess the
market
Be diversified
Scenario analysis and stress testing is important

Risk Management and Financial Institutions 4E, Chapter 28, Copyright John C. Hull 2015

Managing the Trading Room

(page 512-514 )

Do not give too much independence to star

traders
Separate the front middle and back office
Do not blindly trust models
Be conservative in recognizing inception
profits
Do not sell clients inappropriate products
Beware easy profits

Risk Management and Financial Institutions 4E, Chapter 28, Copyright John C. Hull 2015

Liquidity Risk (page 514-517)

The credit crisis of 2007 has emphasized the
importance of liquidity risk
Need to ensure that liquidity funding needs can
be met in stressed market conditions
Beware when many are following the same
strategy
Do not make excessive use of short-term
borrowings for long-term needs
Market transparency is important

Risk Management and Financial Institutions 4E, Chapter 28, Copyright John C. Hull 2015

Lessons for Non-Financial

Corporations (page 517-518)
It

is important to fully understand the

products you trade
Beware of hedgers becoming speculators
It can be dangerous to make the
Treasurers department a profit center

Risk Management and Financial Institutions 4E, Chapter 28, Copyright John C. Hull 2015

A Final Point (page 518-519)

Three

types of risk

Known
Unknown
Unknowable

Flexibility

is important

Risk Management and Financial Institutions 4E, Chapter 28, Copyright John C. Hull 2015