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Financial Risk
Management
Identification, Measurement and Management
Francisco Javier Población García

Financial Risk Management
Financial Risk
Management
Identification, Measurement
and Management
European Central Bank
Frankfurt am Main, Germany
ISBN 978-3-319-41365-5 ISBN 978-3-319-41366-2 (eBook)

DOI 10.1007/978-3-319-41366-2
Library of Congress Control Number: 2016958311
© The Editor(s) (if applicable) and The Author(s) 2017

This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the
whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of
illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and
transmission or information storage and retrieval, electronic adaptation, computer software, or by
similar or dissimilar methodology now known or hereafter developed.
The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication
does not imply, even in the absence of a specific statement, that such names are exempt from the relevant
protective laws and regulations and therefore free for general use.
The publisher, the authors and the editors are safe to assume that the advice and information in this
book are believed to be true and accurate at the date of publication. Neither the publisher nor the
authors or the editors give a warranty, express or implied, with respect to the material contained
herein or for any errors or omissions that may have been made.
Cover image © Maciej Bledowski / Alamy Stock Photo

Cover design by Tom Howey
Printed on acid-free paper
This Palgrave Macmillan imprint is published by Springer Nature

The registered company is Springer International Publishing AG
The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland
Freedom, Sancho, is one of the most precious gifts that heaven has bestowed upon
men; no treasures that the earth holds buried or the sea conceals can compare
with it; for freedom, as for honour, life may and should be ventured . . .
(Don Quixote of La Mancha, Chapter LVIII, second part: The Ingenious
Gentleman Don Quixote of La Mancha, Miguel de Cervantes Saavedra)
To my father
Preface
In recent times, risk analysis and management has become of great impor-
tance in the world of business, but unfortunately, as highlighted by the deep
economic crisis we have become immersed in, this management has not
always been based on purely financial criteria, mainly due to ignorance of
such in certain areas. Perhaps that is what has driven me to write this book.
However, I think my underlying motivation to continue and complete
this task has been the desire to show that risk is not something negative
but quite the opposite, something very positive, as it is the inevitable
consequence of freedom. In other words, if there were no risk, there
would be no freedom, and as was taught by the famous one-armed man
of Lepanto (the name given to Cervantes after fighting in the Battle of
Lepanto) through his most famous fictional character, the ingenious
gentleman Don Quixote of La Mancha: “Freedom is one of the most
precious gifts that heaven has bestowed upon men.” Certainly the exis-
tence of freedom, and therefore risk, allows humankind to acquire human
dignity, as one can read in another bestseller completed in the Middle East
almost 2,000 years ago.
For this reason, the fact that risk exists must be thought of not as a problem
but as an opportunity—an opportunity for people to reach their full poten-
tial. In any event, this is neither the time nor the place to further discuss this
ix
x Preface
interesting theological dilemma, because this book is not about risk in general
but specifically about financial risk and, more specifically, financial risk in an
industrial company.
On another subject and to conclude this short prologue, I would like to
mention that I wrote the first version of this book in Spanish and in doing
so received a tremendous amount of help. First of all, I would like to
thank my former graduate students from CUNEF, Ana Belen Calvo Gago
and Manuel Esteban García González, who collaborated closely with me
on the preparation of this manuscript.
Secondly, I especially appreciate the help I received from Rachel Well
in translating the book from Spanish to English. I have to say that Rachel
is one of the best professionals with whom I have worked.
I would also like to thank Andrés García Mirantes, Juan Manuel Martín
Prieto and Gregorio Serna Calvo for sharing so many years of work with me,
during which I have learnt everything I know about risk analysis and
management. Without them I would not have been able to write this book.
I would also like to thank, and dedicate this book to, all the members of
the risk department at Repsol YPF—whether I have worked with them or
not—the creation of which was inspired by Luis Manas Anton and which
was so efficiently directed by Juan Manuel Martín Prieto.
Finally, I cannot fail to mention the fact that it is God who makes
everything possible, including of course the elaboration of this book.
Contents
Part I Introduction and Perspectives 1
1 Introduction 3
1.1 General Principles 3
1.1.1 Risk 4
1.1.2 The Purpose of Corporate Risk Management:
The Natural Risk Profile 4
1.1.3 Cost–Benefit Analysis 7
1.1.4 Hedging Versus Trading 8
1.1.5 Accounting Recognition 9
1.1.6 Corporate Strategies: Systemic Risk Versus
Idiosyncratic Risk 11
1.2 Individual and Savings Bank Risk Management 12
1.2.1 Individual Risk Management 12
1.2.2 Risk Management in Savings Banks 14
2 Risk Quantification 17
2.1 Basic Concepts 17
2.1.1 Long Positions and Short Positions 18
2.1.2 Derivative Assets 19
xi
xii Contents
2.1.2.1 Greek Letters 25

2.1.3 Linear Exposure 26
2.1.4 Option Type Exposure 28
2.2 Types of Risk 30
2.2.1 Market Risk 30
2.2.1.1 Equity 30
2.2.1.2 Interest Rate 31
2.2.1.3 Exchange Rate 32
2.2.1.4 Commodities 33
2.2.2 Credit Risk 34
2.2.2.1 Counterparty Risk 35
2.2.3 Other Risks 36
2.2.3.1 Operational Risk 36
2.2.3.2 Liquidity Risk 37
2.3 The Accounting Impact of Hedging 37
Part II Market Risk 39
3 One-Dimensional Market Risk; Equity Risk 41

3.1.1 Terminology 42
3.2 Probabilistic Model 44
3.3 Value at Risk (VaR) 49
3.3.1 Concept 49
3.3.2 Theoretical Calculation and Examples 53
3.3.3 Empirical VaR Calculation 56
3.3.3.1 Numerical Simulation (Monte
Carlo Experiment) 56
3.3.3.2 Historical Simulation 60
3.3.3.3 Concrete Simulation Scenarios 62
3.4 Incremental and Marginal Measures 65
3.4.1 General Ideas 65
3.4.2 Formal Definition 67
Contents xiii
3.5 VaR Applications 69

3.5.1 Relationship to Risk–Return Approach 69
3.5.2 Diversification and Hedging 70
4 Multidimensional Market Risk 75

4.1.1 Cash Flow and Net Present Value 75
4.1.2 Multi-Period Measures Concept and
Classification 76
4.2 Probabilistic Models 77
4.2.1 Time Series (Stochastic Processes) 77
4.2.2 Intertemporal Volatility and Correlation 82
4.2.3 Temporal Aggregation and Considerations on
Interest Rates 84
4.3 Risk Measures 84
4.3.1 Measures Without Discount: The CFaR 84
4.3.2 Measures with Discount: The NPVaR 86
4.4 Calculation Methodology 87
4.4.1 Analytical Estimation 87
4.4.1.1 Example of Analytical Calculation
of the CFaR 88
4.4.1.2 The Analytical Estimation of
NPVaR 90
4.4.2 Numerical Estimation (Simulation) 91
4.4.3 Calculation Without an Explicit Model 97
4.5 Diversification and Hedging Considerations 98
5 Interest Rate Risk 101

5.1.1 Different Fixed-Income Instruments 102
5.1.2 Different Ways of Characterising the Interest
Rate 103
5.1.3 The Risk Premium 104
5.1.4 Interest Rate Risk and Inflation 106
xiv Contents
5.2 The Term Structure of Interest Rates 108

5.2.1 Term Structure Theories of Interest Rates 110
5.2.2 The Implicit Interest Rate, the Forward
Interest Rate and IRR 115
5.3 Duration 116
5.3.1 Simple or Macaulay Duration and Modified
Duration 116
5.3.2 Convexity 119
5.3.3 Portfolio Immunisation 122
5.4 The VaR for Fixed Income 125
5.5 Interest Rate Derivatives 128
5.5.1 Interest Rate Futures 128
5.5.2 Forward Rate Agreement (FRA) and Interest
Rate Swap (IRS) 129
5.5.3 Cap, Floor and Collar 130
5.6 Structured Bonds 133
6 Exchange Rate Risk 135

6.1.1 Exchange Rate Markets 136
6.1.2 Types of Exposure with Exchange Rate Risk 139
6.2 Denomination Currency Versus Exposure Currency 141
6.2.1 Estimation of Exposure Currency 144
6.3 VaR in the Exchange Rate 148
6.4 Exchange Rate Derivatives 149
6.5 Exchange Rate Hedging under Uncertainty in Cash
Flows 150
6.6 Relationship between Interest Rate and Exchange Rate 151
7 Price Risk in Commodities 155

7.1.1 Storage Costs 156
7.1.2 Convenience Yield 157
7.1.3 The Forward Curve 158
7.1.4 Seasonality 160
Contents xv
7.2 Commodity Price Dynamics 162

7.2.1 Mean Reversion 162
7.2.2 Factorial Models 163
7.3 VaR Calculation for Commodities 167
7.4 Risk Management in Commodities 167
8 Market Risk Hedging 171

8.1.1 Hedging Costs and Profits 171
8.1.2 The Residual Risk 173
8.2 Types of Hedging 174
8.3 Hedging Instruments 178
8.3.1 Derivative Assets 178
8.3.1.1 Payment System Design 179
8.3.1.2 Derivative Asset Valuation 182
8.3.1.3 Risk Management in Derivatives 186
8.3.2 Embedded Derivatives 187
8.4 Hedge Accounting 190
8.4.1 General Issues 190
8.4.1.1 Held-to-Maturity Investment
Accounting 190
8.4.1.2 Derivative Accounting 191
8.4.2 Types of Hedge Accounting 195
8.4.3 Embedded Derivatives Accounting 197
Part III Credit Risk 199
9 Credit Risk: Measurement 201

9.1.1 Credit Risk Versus Market Risk 202
9.1.2 The Credit Event 203
9.1.2.1 Default Definition in Banking
Regulation 205
xvi Contents
9.2 Measuring Credit Risk 206

9.2.1 Probability of Default (PD) 207
9.2.1.1 Estimates from Historical Data
(Credit Scoring/Rating) 207
9.2.1.2 Estimates from Bond Prices 219
9.2.1.3 Estimates from Share Prices and
Volatility 223
9.2.2 Loss Given Default (LGD) 225
9.2.2.1 Banks’ Regulatory Requirements
for LGD Calculation 228
9.2.3 Exposure at Default (EAD) 231
9.2.3.1 Banks’ Regulatory Requirements
for EAD Calculation 232
9.3 Expected Loss Versus Unexpected Loss 233
10 Credit Risk: Validation 235

10.2 Qualitative Validation 236
10.3 Quantitative Validation 236
10.3.1 Discriminatory Power 236
10.3.1.1 Rating/Scoring Systems:
Probability of Default (PD) 236
10.3.1.2 LGD and EAD 243
10.3.2 Parameters 244
10.3.2.1 Predictive Power: Back-Testing 244
10.3.2.2 Benchmarking 247
11 Credit Risk Management 249

11.2 Traditional Management 250
11.2.1 Retail and Corporate Portfolios 251
11.2.1.1 The Retail Portfolio 251
11.2.1.2 The Corporate Portfolio 252
11.2.2 Capital Requirements 253
11.2.2.1 Non-defaulted Assets 253
Contents xvii
11.3 Hedging with Derivatives 257

11.4 Stress Test 260
12 Derivative Credit Risk (Counterparty Risk) 265

12.2 OTC Markets Versus Organised Markets 266
12.2.1 OTC Markets 266
12.2.1.1 International Swaps and
Derivatives Association:
Framework 268
12.2.2 Organised Markets 269
12.2.2.1 The Clearing House 270
Part IV Other Risks 275
13 Operational Risk 277

13.1.1 Definition of Operational Risk 277
13.2 Operational Risk Measurement 281
13.2.1 Loss Function 281
13.2.2 Databases 283
13.2.3 Approaches to Operational Risk Measurement 284
13.3 Operational Risk Mitigation Systems 285
13.3.1 Insurance 287
13.3.2 Financial Hedges 289
13.4 Approach to Operational Risk in Basel II:
Determination of Regulatory Capital 290
14 Liquidity Risk 293

14.1.1 Types of Liquidity Risk and Its Relationships
with Other Risks 294
xviii Contents
14.2 Liquidity Risk Measurement 295

14.2.1 Static Measurement 296
14.2.2 Dynamic Measurement 297
14.2.3 Pricing Liquidity Risk 298
14.2.4 Methods to Assess Liquidity Risk: Liquidity
Stress Test 299
14.3 Liquidity Risk Management 300
14.3.1 Liquidity Crisis 302
15 Country Risk 305

15.1.1 Country Risk in a Strict Sense 306
15.1.2 Country Risk in a Broad Sense 307
15.2 Variables Influencing Country Risk 309
15.3 Adjustments to the Cost of Capital: The Country
Risk Premium 312
15.4 Regulatory Risk/Legal Risk 315
15.4.1 Regulatory Risk in OECD Countries 316
15.4.2 The Examples of Bolivia and Argentina 317
15.4.3 Risks in Accounting 318
15.5 Country Risk Management 319
Part V Financial Implications of Risk 321
16 The CAPM 323

16.2 Portfolio Theory 324
16.2.1 Graphical Representation of Portfolios in the
Mean: Standard Deviation Plan 326
16.2.2 Efficient Portfolios 330
16.2.2.1 Analytic Derivation of the Efficient
Portfolio Frontier 330
Contents xix
16.2.2.2 Analytic Derivation of the

Minimum Variance Portfolio 336
16.2.2.3 The Introduction of the Risk-Free
Asset: The Capital Market Line
(CML) 337
16.3 The CAPM 340
16.3.1 The Securities Market Line (SML) 340
16.3.2 The Market Model 342
17 The WACC 345

17.2 WACC Calculation 347
17.2.1 The Risk Premium 349
17.3 The WACC of an Investment Project 350
17.3.1 Risk-Adjusted Cash Flows 351
18 Conclusions 353
Glossary of Terms 359
Bibliography 385
Index 391
List of Figures
Fig. 1.1 Corporate risk management, business strategy and financial

strategy 8
Fig. 2.1 Future buyer payment (Author’s own composition) 20
Fig. 2.2 Future seller payment (Author’s own composition) 21
Fig. 2.3 European call buyer payment (Author’s own composition) 22
Fig. 2.4 European call seller payment (Author’s own composition) 22
Fig. 2.5 European put buyer payment (Author’s own composition) 23
Fig. 2.6 European put seller payment (Author’s own composition) 23
Fig. 3.1 STOXX Europe 600 (Source: Bloomberg) 45
Fig. 3.2 Returns, STOXX Europe 600 (Source: Bloomberg) 45
Fig. 3.3 Absolute frequency profitability (continuous) of the IBEX
35 (Source: Bloomberg) 47
Fig. 3.4 IBEX Profitability (Source: Bloomberg) 48
Fig. 3.5 VaR calculation (Author’s own composition) 51
Fig. 3.6 Probability distribution with a high σ (Author’s own
composition) 52
Fig. 3.7 Probability distribution with a low σ (Author’s own
composition) 52
Fig. 3.8 Portfolio value (scenario simulation) (Author’s own
composition) 59
Fig. 3.9 Probability distribution of the portfolio value at t ¼ 1
(Author’s own composition) 59
xxi
xxii List of Figures

Fig. 4.1 Independent variable process (Author’s own composition) 79
Fig. 4.2 Random walk (Author’s own composition) 80
Fig. 4.3 Comparative processes (Author’s own composition) 81
Fig. 4.4 Moving average process (Author’s own composition) 83
Fig. 4.5 Crude oil prices (simulation scenarios) (Author’s own
composition) 94
Fig. 4.6 Probability distribution of the NPV (Author’s own
composition) 94
Fig. 4.7 Probability distribution of CFT (Author’s own composition) 95
Fig. 5.1 Bonds interest rate (Data source: Bloomberg; Author’s own
composition) 104
Fig. 5.2 Zero-coupon curve government debt in Spain
(Data source: Bloomberg; Author’s own composition) 109
Fig. 5.3 Zero-coupon curve (Author’s own composition) 109
Fig. 5.4 Convexity (Author’s own composition) 120
Fig. 5.5 Convexity (Author’s own composition) 121
Fig. 5.6 Portfolio immunisation (Author’s own composition) 124
Fig. 5.7 Cap (Author’s own composition) 132
Fig. 5.8 Floor (Author’s own composition) 132
Fig. 5.9 Collar (Author’s own composition) 133
Fig. 6.1 Exchange rate $/€ (Data source: Bloomberg; Author’s own
composition) 137
Fig. 6.2 Exchange rate £/€ (Data source: Bloomberg; Author’s own
composition) 137
Fig. 6.3 Exchange rate ¥/$ (Data source: Bloomberg; Author’s own
composition) 138
Fig. 6.4 Exchange rate €/$ (Data source: Bloomberg; Author’s own
composition) 142
Fig. 6.5 Comparison of €/$ exchange rate and product price in $
Fig. 6.6 Comparison of €/$ exchange rate and product price in €
Fig. 6.7 Comparison of crude oil price in $/bbl and €/$ exchange rate
List of Figures xxiii
Fig. 6.8 Comparison of crude oil price in €/bbl and €/$ exchange rate
Fig. 6.9 Comparison of crude oil price in $/bbl and Argentine pesos/$
exchange rate (Data source: Bloomberg; Author’s own
composition) 147
Fig. 6.10 Comparison of crude oil price in Argentine pesos/bbl and
Argentine pesos/$ exchange rate (Data source: Bloomberg;
Author’s own composition) 147
Fig. 6.11 Relationship between interest rate and exchange rate
Fig. 7.1 Crude oil forward curve (Data source: Bloomberg; Author’s
own composition) 161
Fig. 7.2 Natural gas forward curve (Data source: Bloomberg; Author’s
Fig. 7.3 Repsol (Data source: Bloomberg; Author’s own composition) 163
Fig. 7.4 BP (Data source: Bloomberg; Author’s own composition) 164
Fig. 7.5 Chevron (Data source: Bloomberg; Author’s own
composition) 164
Fig. 7.6 Gold price (Data source: Bloomberg; Author’s own
composition) 165
Fig. 7.7 Crude oil (WTI) price (Data source: Bloomberg; Author’s
Fig. 8.1 Put hedging 181
Fig. 8.2 Collar (put and call) hedging 182
Fig. 8.3 Call 185
Fig. 8.4 Put 185
Fig. 8.5 Collar hedging 189
Fig. 9.1 Long-run PD (Author’s own composition) 215
Fig. 9.2 Long-run PD (Author’s own composition) 217
Fig. 9.3 Asset value (Author’s own composition) 224
Fig. 9.4 Probability (Author’s own composition) 234
Fig. 10.1 Default per rating class (Author’s own composition) 237
Fig. 10.2 Density functions (Author’s own composition) 238
Fig. 10.3 Cumulative frequency functions (Author’s own composition) 239
Fig. 10.4 ROC curve (Author’s own composition) 240
Fig. 10.5 Cap curve (Author’s own composition) 242
Fig. 10.6 Power curve (Author’s own composition) 243
xxiv List of Figures
Fig. 10.7 LGD model and perfect model comparison (Author’s own
composition) 244
Fig. 11.1 Default rate—construction (Author’s own composition) 262
Fig. 11.2 Default rate—projections (Author’s own composition) 262
Fig. 12.1 Profit and loss over time (Author’s own composition) 272
Fig. 13.1 Probability vs. loss (Author’s own composition) 281
Fig. 16.1 Expected profit–risk graph (Author’s own composition) 326
Fig. 16.2 Portfolio average return and standard deviation (Author’s own
composition) 329
Fig. 16.3 Efficient portfolios (Author’s own composition) 335
Fig. 16.4 Minimum variance portfolio (Author’s own composition) 337
Fig. 16.5 The efficient frontier and the risk-free rate (rF) (Author’s own
composition) 338
Fig. 16.6 Investors on the capital market line (Author’s own
composition) 339
Fig. 16.7 An isolated security that lies below the CML (Author’s own
composition) 341
Fig. 16.8 β and expected return (Author’s own composition) 343
List of Tables
Table 3.1 Aggregation 44

Table 3.2 Estimated probability 60
Table 4.1 Estimated probability (Author’s own composition) 95
Table 4.2 Maximum loss regarding expected value (5 %, M€)
Table 9.1 Grades 212
Table 9.2 Short-term ratings 213
Table 9.3 Rating transition probability matrix (Author’s own
composition) 214
Table 9.4 Expected loss of default (Author’s own composition) 222
Table 10.1 Rating class comparison (Author’s own composition) 237
Table 10.2 Rating class comparison (Author’s own composition) 238
Table 10.3 Individual significance (Author’s own composition) 241
Table 13.1 Various sources that can cause operational risk
Table 13.2 “Beta” factors (Author’s own composition) 291
Table 15.1 Main variables that influence country risk
Table 16.1 Shares estimates (Author’s own composition) 325
xxv
xxvi List of Tables
Table 16.2 Variance–covariance matrix (Author’s own composition) 328

Table 16.3 The average return and standard deviation of five portfolios
Table 16.4 Average return Re and volatility (Author’s own composition) 334
Table 16.5 Coordinates of the minimum variance portfolio (Author’s
Part I
Introduction and Perspectives
1
Introduction
1.1 General Principles

In general, it can be said that risk has always been present in companies
and therefore, measurement and management of risk has always been
important. In recent times, due to the increasing internationalisation of
corporations and the fact that economic activity is increasingly dependent
on technology, risk measurement and management has become critical in
all companies, regardless of their sector of activity.
The results of a company are subject to risks arising from the manage-
ment of its assets and the development of its business strategy. All economic
activity, even buying government debt, is subject to risk since, as has
recently been demonstrated, there is always a risk that the state cannot
pay its debts or cannot do so in the time and manner agreed at the time
of issue. Even if the debts are paid in this time and manner, a great deal of
value can be lost (currency depreciation, hyperinflation, etc.).
Therefore, although there is often no awareness of this, risks are run
and it is unclear which carries more risk: to take a specific action, to take a
number of actions or not to take any action at all. For this reason, the first
© The Author(s) 2017 3

F.J. Población García, Financial Risk Management,
DOI 10.1007/978-3-319-41366-2_1
4 Financial Risk Management
thing that has to be done to analyse a company’s risk is to define some

general principles and concepts.
1.1.1 Risk
The word risk has multiple meanings. Thus, it is necessary to specify what is
understood when discussing the concept of risk. For the purposes of this
book, we define risk as the degree of uncertainty that exists about the return
of future net cash flows generated by making a particular investment.
This definition is very general and involves many different aspects
which will be dealt with in detail throughout this book. For the moment,
based on this general definition, this first chapter will try to shed some
light on the purpose of risk management in an industrial company.
1.1.2 The Purpose of Corporate Risk Management: The

Natural Risk Profile
The purpose of a business is to develop economic activity and this involves

managing risk, which is why the first step must be to define the company’s
“natural” risk profile.
The “natural” risk profile of a company is defined as the recurrent risk
derived from the efficient management of assets, with purchases and sales
carried out in accordance with standard market practices. Bearing this
definition in mind, the purpose of corporate risk management is to
determine the risk profile that the company intends to offer its investors
based on a cost–benefit analysis of natural risk profile alternatives. That is
to say, the primary objective of the directors of a company is to maximise
its value, or in other words to maximise the value of its shares. As far as risk
management is concerned, the company responsible must offer investors,
who are potential buyers of its shares, a risk profile that best fits their
demand.
In an ideal world, the investor’s risk aversion should not be relevant for
this analysis, since the investor can diversify their portfolio. This implies
that if the investor is averse to risk, they can invest in different assets and
1 Introduction 5
thus achieve a level of risk with which they feel comfortable. However,
principal–agent problems are always present, that is, the directors have
more information about the company than the investors. The investors
may become wary of companies which they perceive to be high risk, even
if they are expected to be highly profitable.
In addition, hedging risks helps avoid costs related to “financial dis-
tress”, that is, costs (direct and indirect) associated with defaults and
bankruptcy. This includes premiums payable to counterparties (cus-
tomers, employees, partners, manufacturers, etc.) during a period of
financial distress. At a time when a company is close to bankruptcy, the
best employees go to other companies, industry partners become wary and
are unwilling to collaborate in economic activities, suppliers tend not to
provide goods due to the threat of defaults, customers do not buy from
the company as in the future they will not be able to find parts for their
products, and so on.
In addition, it must be taken into account that the opportunity to
participate in potentially profitable investment projects is lost if there is a
lack of liquidity, since in times of financial distress banks, along with
international investors, are very reluctant to provide funding. This is partic-
ularly relevant in leading technology sectors, in which a novel discovery or
development could present an immediate need to make large investments
which could not be carried out without sufficient financial leverage.
On the other hand, it has to be said that selective risk hedging could
create value in the company, increasing its borrowing capacity (with the
tax benefits that entails) without compromising financial flexibility.
Given the above, it is possible to establish the general principle that, in an
ideal world, a company’s hedging strategies should focus on aspects over which
it has no control or competitive advantage. In other words, hedging strategies
should enable the company to focus on its “competitive advantages”. Ideally, if
hedging instruments incurred no costs, companies would strictly moderate the
intrinsic risk of the business. However, typically hedging comes at considerable
cost (as indicated above, principal–agent problems, including financial distress,
must be taken into account).
In addition, other factors have to be considered when determining the
risk profile of a company, two of which must be highlighted above all
others: the impact on accounting and the preference that potential clients
6 Financial Risk Management
have for certain risk profiles. Financial statements collect information

which is released into the market and is validated by an independent
third party. The financial statements themselves do not generate either
profits or losses. However, as a rule, accounting standards and the relative
recognition of hedging, especially International Accounting Standard
(IAS) 39, are general, of a conservative nature and unable to adapt to
each individual case, and therefore they do not always allow accounting
statements to reflect the results of hedging strategies in the most appro-
priate way. These “imperfections” together with disproportionate infor-
mation problems could cause concern for investors and, as a result, a fall in
the value of shares. It is for this reason that the possible modification of
the natural risk profile is always considered. It is essential to consider the
accounting aspect. The case could arise, and in fact has arisen, in which
hedging is perfect economically (or, from an economic-financial point of
view, the risk being covered has almost completely disappeared) but is not
perceived as such from an accounting perspective. This is particularly
likely to happen when the accounting standard requires the asset (which
may be a permanent investment for the company) to be recorded at its
purchase price, while its hedging (usually a financial derivative) is recorded
at the market price at the time. This causes accounting distortions which
are difficult for the company to explain and difficult to understand in the
market.
On the other hand, we must also consider that different investors
from different sectors (“retail”/institutional, local/international, etc.)
may have a preference for different risk profiles. Taking the hedging
practices of the sector into account, the company may choose to offer
its investors a definite risk profile or offer specific investment products. In
other words, the goal of the company is to create value for its shareholders
and, in particular, to try to increase the value of their shares as much
as possible. Thus, when choosing the risk profile of the company, it is
important to take into account what the market is demanding in terms of
risks.
Although ideally companies should monitor their intrinsic business risk,
in practice, as will be demonstrated, in many cases this is not desirable or
appropriate once the costs have been analysed.
1 Introduction 7
1.1.3 Cost–Benefit Analysis
Obviously, in order to modify the natural risk profile of a company, there

must be another person or entity (counterparty) willing to take the part of
the risk that the company does not want to accept. To perform this risk
transfer, some type of financial instrument must be used, for example
derivative assets.1 In addition, both finding and convincing a counterparty
to assume the risks that the company will not, and the instruments which
are used to transfer this risk, come at a price. To clarify, these costs can be
divided into three categories.
The first category corresponds to what are known as intermediation
costs. These costs are related to the fact that both the counterparty and the
agencies that create the financial instruments necessary for risk transfer
charge all kinds of commission. Similarly, the market clearly shows that
the price a counterparty is willing to pay will be lower than the price it is
willing to sell for (the “bid–ask spread”), which is, in one way or another,
an expense.
The second category relates to what is known as counterparty risk.
Although counterparty risk will be dealt with in subsequent chapters, this
can be defined simply as the risk resulting from the possibility that, at the
time of settlement, the counterparty fails to meet its commitments. This
counterparty risk can be minimised using periodic settlement mechanisms
(which is expensive), or using clearing houses that charge fees specifically
for hedging against counterparty risk. Furthermore, these mechanisms
lead to a risk of liquidity.2
The third category consists of administration and control costs. As its
name suggests, this is the cost of managing the company and of monitor-
ing counterparties and instruments used to modify the natural risk profile.
Although these costs are usually not too high, they can become especially
significant when considering complex hedging strategies which require
constant modifications (such as regular adjustments to the portfolio).
1
Subsequent chapters will discuss the concept of a derivative asset in more detail.
2
All of these concepts (periodic settlement, clearing, counterparty risk, risk of liquidity, etc.) will be
developed in detail in subsequent chapters.
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regarded in the light of a leader, since his decision seems to have
been esteemed by them as a sort of law; and the perfect
acquiescence of even the most troublesome in the course which he
recommended, is a proof of his predominant influence. The tone and
style of the address itself, also imply that the speaker thought he had
good reason to believe that others were looking to him in particular,
for the decision which should regulate their opinions on this doubtful
question. After Simon Peter, as the great chief of the apostles, had
first expressed his opinion on the question under discussion, and
had referred to his own inspired divine revelations of the will of God
in respect to the Gentiles, Paul and Barnabas next gave a full
account of their operations, and of the signs and wonders with which
God had followed their labors.
After the full exposition made by Paul and Barnabas, of all their
conduct, James arose to make his reply in behalf of the close
adherents of Mosaic forms, and said, “Men and brethren! listen to
me. Simeon has set forth in what manner God did first condescend
to take from the heathen a people for his name. And with this, all the
words of the prophets harmonize, as it is written, ‘After these things I
will turn back, and will rebuild the fallen tabernacle of David; I will
both rebuild its ruins and erect it again, in order that the rest of
mankind may seek out the Lord, together with all the heathen who
are called by my name, saith the Lord who made all things.’ ‘Well
known to God are all his works from eternity.’ So I think that we
ought not to make trouble for those who have turned from the
heathen, to God; but that we should direct them to refrain from things
that have been offered unto idols, and from fornication, and from
what has been strangled, and from blood. For Moses has, from
ancient generations, in these cities, those who make him
known,――his law being read every sabbath day.” This opinion,
formed and delivered in a truly Christian spirit of compromise, seems
to have had the effect of a permanent decision; and the great leader
of the rigid Judaizers, having thus renounced all opposition to the
adoption of the converted heathen into full and open Christian
communion, though without the seals of the Mosaic covenant,――all
those who had originated this vexatious question, ceased their
attempts to distract the harmony of the apostles; and the united
opinions of the great apostolic chief, who had first opened the gates
of Christ’s kingdom to the heathen, and of the eminent defender of
Mosaic forms, so silenced all discussion, that thenceforth these
opinions, thus fully expressed, became the common law of the
Christian churches, throughout the world, in all ages.
This address of James (Acts xv. 13‒21.) may justly be pronounced the most obscure
passage of all that can be found in the New Testament, of equal length,――almost every
verse in it containing some point, which has been made the subject of some dispute.
Schoettgen (quoted by Bloomfield,) thus analyzes this discourse:――“It consists of three
parts;――the Exordium, (verse 13,) in which the speaker uses a form of expression
calculated to secure the good-will of his auditors;――the Statement, (verses 16‒18,)
containing also a confirmation of it from the prophets, and the reason;――the Proposition,
(verses 19‒20,) that the Gentiles are not to be compelled to Judaism, but are only to
abstain from certain things particularly offensive to the spirit of the Mosaic institutions.”
Simeon. (verse 14.) This peculiar form of Peter’s first name, has led some to suppose
that he could not be the person meant, since he is mentioned in all other narratives by the
name of Simon. Wolf imagines that Simon Zelotes must have been the person thus
distinguished, though all the difficulties are the same in his case as in Peter’s. But Simeon
(Συμεων) and Simon are the same name, the latter being only an abridged form, better
suited to the inflections of the Greek than the former.――This preference of the full Hebrew
form was doubtless meant to be characteristic of James, who seems to have been in
general very zealous for ancient Jewish usages in all things.
Has condescended to take. Common translation: “did visit them to take,” &c. This much
clearer translation is justified by the meaning which Bretschneider has given to επισκεπτομαι,
benigne voluit, &c., for which he quotes the Greek of the Alexandrian version.
Harmonize. (verse 15.) The original (συμφωνοῦσιν) refers in the same manner as this
word does to the primary idea of accordance in sound, (symphony,) and thence by a
metonymy is applied to agreement in general. The passage of prophecy is quoted by James
from Amos ix. 11, 12, and accords, in the construction which he puts upon it, much better
with the Alexandrian Greek version, than with the original Hebrew or the common
translations. The prophet (as Kuinoel observes) is describing the felicity of the golden age,
and declares that the Jews will subdue their enemies and all nations, and that all will
worship Jehovah. Now this, James accomodates to the present purpose, and applies to the
propagation of the gospel among the Gentiles, and their reception into the Christian
community. (See Rosenmueller, Acts, xv. 17, for a very full exegesis of this passage.)
Well known to God are all his works. These words have been made the subject of a
great deal of inquiry among commentators, who have found some difficulties in ascertaining
their connection with the preceding part of the discourse. Various new and unauthorized
renderings of the words have been proposed, but have been generally rejected. It seems to
me that the force of the passage is considerably illustrated by throwing the whole emphasis
of the sentence upon the word “all,”――“Known unto God are all his works from the
beginning of ages.” James is arguing on the equal and impartial grace of God, as extended
not only to the Jews, but also to the Gentiles;――not to one nation merely, but to all his
creatures. “Thus saith the Lord who makes (or does) all things.” The original Hebrew of the
prophecy indeed, does not contain this, but that is itself a circumstance which shows that
James had a particular object in this ♦ accommodation of the words to this form and
purpose.
♦ “accomodation” replaced with “accommodation”
So I think, &c. (verse 19.) Hammond and others have attempted to find in the original of
this verb (κρινω) a peculiar force, implying that James announced his decision with a kind of
judicial emphasis, in the character of “Bishop of Jerusalem.” The groundlessness of this
translation is shown by Bloomfield’s numerous references to classical authority for the
simple meaning of “think.” The difficulties in the twentieth verse are so numerous and
weighty, and have been made the subject of such protracted and minute discussions by all
the great commentators, that it would be vain to attempt any account of them here.
The great eminence of James among the apostles is very fully

shown in several incidental allusions made to him in other passages
of the apostolic writings. Thus when Peter, after his miraculous
release from prison, came to the house of Mary the mother of John
Mark, he, at departing from the Christians there assembled, told
them to tell James and the brethren; implying, of course, that James
was altogether the most prominent person among them, and might
justly be considered chief apostle in the absence of Peter; and that
to him any message intended for all, might be appropriately first
addressed. In the same way did the angel, at the resurrection of
Jesus, distinguish Peter among all the apostles, mentioning him
alone by name, as the individual person to whom the divine
message was to be delivered.
But no where is his eminence among the apostles so strongly

marked, as in Paul’s account of his own visits to Jerusalem, and the
incidents connected with them. He there mentions “James, the
brother of our Lord,” in such terms as to show that he must have
been one of the apostles; thus adding a valuable confirmation to the
testimony above adduced in favor of this very point, that James, the
brother of Jesus, was an apostle. Paul’s words are, “Other of the
apostles, (besides Peter,) saw I none, except James, the Lord’s
brother;” an expression which all analogy requires to be construed
into a clear assertion that this James was an apostle. In speaking of
his second visit, fourteen years after, Paul also bears a noble
testimony to the eminence of James, and, what is remarkable, gives
him the very first place among those three whom he mentions by
name. He says, “When James, Cephas, and John, who seemed to
be pillars, perceived the grace that was given to me, they gave to me
and Barnabas the right hand of fellowship.” This very peculiar
arrangement of these three great names, has seemed so strange to
the more stubborn Papists, that they can not believe that the Cephas
here mentioned in the second place, is their great idol, Peter; and
many of them have maintained, in long arguments, that he was not
Peter,――a notion which might seem plausible at first glance, from
the circumstance, that throughout his whole narrative, Paul has been
speaking of Peter by the common Greek form of his surname, while
in this particular passage, he uses the original Hebrew word,
Cephas. But this verbal change is of no consequence whatever,
except as showing that in this connection there was something which
suggested a preference of the Hebrew name, while mentioning him
along with the two other great apostolic chiefs, James and John. And
even this very peculiar promotion of James to the first place, is easily
explained by a consideration of the subject in connection with which
these personages are mentioned. James was unquestionably the
great leader of the sticklers for Mosaic forms; and he is therefore the
most important person to be quoted in reference to Paul’s reception,
while the dissensions about circumcision were raging. Peter, on the
other hand, being himself the great champion of open Gentile
communion, from his having been himself the first of all men to bring
them under the gospel, was, of course, understood to be a favorer of
Paul’s views, of the noble catholic extension of Christianity; and his
name was therefore of really less importance in Paul’s statement,
than the name of James, who was everywhere known as the head of
the circumcision party, and being mentioned as having shown such
respect to Paul, would make it evident that the two Hellenist apostles
were taken into favor by all parties, and heartily commended to the
great work of evangelizing the heathen.
The especially watchful zeal of James, for the preservation of
Mosaic forms, is very distinctly implied in another passage of the
same epistle. He had, in a nobly considerate spirit of compromise,
agreed that it was best to receive all the Gentile converts as
Christian brethren, though they conformed only very partially to the
Mosaic institutions. It was perfectly a matter of common sense, to
every reasonable man, that the progress of the gospel would be
greatly hindered, and almost brought to a stand, among the heathen,
if a minute adherence to all the corporeal observances of the
Levitical code, were required for Christian communion; and James,
though profoundly reverencing all the requirements of his national
religion, was too wise to think of imposing all these rituals upon
those whose whole habits would be at war with the observance of
them, though in heart and in life they might be fully fitted to
appreciate and enjoy the blessings of Christ’s spiritual covenant. He
therefore distinctly expressed his accordance with Peter, in these
general principles of Christian policy, yet, as subsequent events
show, he was by no means disposed to go to all lengths with the
more zealous chief of the apostles, in his readiness to renounce, in
his own person, all the peculiarities of Jewish habits; and seems to
have still maintained the opinion, that the original, pure Hebrew
apostles, should live in the most scrupulous observance of their
religious exclusiveness, towards those whom the Levitical law would
pronounce unclean, and too much polluted with various defilements,
to be the familiar associates of a truly religious Jew. This sentiment
of James appears to have been well known to Peter, who, conscious
of the peculiar rigidity of his great apostolic associate, on these
points, wisely sought to avoid all occasions of needlessly exciting
complaints and dissensions among the chief ministers of the word of
truth. For this reason, as has already been narrated in his life, when
he was at Antioch, though during the first part of his residence there,
he had, without the slightest scruple, gone familiarly and frequently
into the company of the unbelieving Gentiles, eating and drinking
with them, without regard to any liability to corporeal pollutions, that
were against the rules of Levitical purity,――yet when some persons
came down from ♦ Jerusalem, from James, he entirely withdrew
himself, all at once, within the strict bounds of Mosaic observances.
Perhaps these visitors from James had been specially instructed by
him to note the demeanor of Peter, and to see whether, in his zeal
for removing all obstruction out of the way of the Gentile converts, he
might not forget what was due to his own character as a descendant
of Abraham, and a disciple of him who so faithfully fulfilled all the
righteousness of the law. However this might be, Peter’s actions
plainly expressed some dread of offending James, and those who
came from him; else he certainly would not have refrained, in this
remarkable manner, from a course of conduct, which he had before
followed unhesitatingly, as though he had not the slightest doubt of
its perfect moral propriety; and the conclusion is reasonable, that he
now changed his demeanor, only from views of expediency, and a
regard to the jealous sensitiveness of his great associate, on points
of Levitical law.
♦ “Jerasalem” replaced with “Jerusalem”
his apostolic office.
From these and other passages, implying a great eminence of

James in the direction of the plans of evangelization, it is evident,
that, in the absence of Peter, he must have been the most important
person among the apostles at Jerusalem; and after the permanent
removal of the commissioned apostolic chief, to other and wider
fields of action, his rank, as principal person among all the ministers
of Christ in Jerusalem, must have been very decidedly established.
From this circumstance has originated the notion that he was “bishop
of Jerusalem;” and this is the title with which the later Fathers have
attempted to decorate him,――as if any honor whatever could be
conferred on an apostle, by giving him the title of a set of inferior
ministers appointed by the original commissioned preachers of
Christ, to be merely their substitutes in the instruction and
management of those numerous churches which could not be
blessed by the presence of an apostle, and to be their successors in
the supreme earthly administration of the affairs of the Christian
community, when the great founders had all been removed from their
labors, to their rest. How nearly the duties performed by James
corresponded to the modern episcopal function, it is utterly
impossible to say, for the simple reason that not the slightest record
of his actions is left, to which references can be made, on this
interesting question. That he was the most eminent of the apostles
resident at Jerusalem, is quite clear; and that by him, under these
circumstances, were performed the great proportion of the pastoral
duties among the believers in that city, may be most justly supposed;
and his influence over Christian converts would by no means be
limited by the walls of the Holy city. In his apostolic functions, he, of
course, became known to all resorting to that place; and his faithful
and eminent ministry in the capital of the Jewish religion would
extend not only his fame, but the circle of his personal
acquaintances, throughout all parts of the world, from which pilgrims
came to the great annual festivals in Jerusalem. His immense
apostolic diocese, therefore, could not be very easily bounded, nor
was it defined with any exactness, to prevent it from running into the
limits of those divisions of the fields of duty, in which Peter, Paul,
John and others, had been more especially laboring. His influence
among the Jews in general, (whether believers in Christ or not,)
would, from various accounts, appear to have been greater than that
of any other apostle; and this, combined with the circumstances of
his location, would seem to entitle him very fairly to the rank and
character of the apostle of the “Dispersion.” This was a term
transferred from the abstract to the concrete sense, and was applied
in a collective meaning to the great body of Jews in all parts of the
world, through which they were scattered by chance, choice, or
necessity.
Bishop of Jerusalem. The first application of this title to James, that appears on record,
is in Eusebius, who quotes the still older authority of Clemens Alexandrinus. (Church
History, II. 1.) The words of Eusebius are, “Then James, who was called the brother of our
Lord, because he was the son of Joseph, and whom, on account of his eminent virtue,
those of ancient times surnamed the Just, is said to have first held the chair of the bishopric
of Jerusalem. Clemens, in the sixth book of his Institutes, distinctly confirms this. For he
says that ‘after the Saviour’s ascension, although the Lord had given to Peter, James, and
John, a rank before all the rest, yet they did not therefore contend among themselves for
the first distinction, but chose James the Just, to be bishop of Jerusalem.’ And the same
writer, in the seventh book of the same work, says these things of him, besides: ‘To James
the Just, and John, and Peter, did the Lord, after the resurrection, grant the knowledge, [the
gnosis, or knowledge of mysteries,] and these imparted it to the other disciples.’”
In judging of the combined testimony of these two ancient writers, it should be observed
that it is not by any means so ancient and direct as that of Polycrates, on the identity of
Philip the apostle, and Philip the deacon, which these very Fathers quote with assent. Nor
can their opinion be worth any more in this case than in the other. On no point, where a
knowledge of the New Testament, and a sound judgment are the only guides, can the
testimony of the Fathers be considered of any value whatever; for the most learned of them
betray a disgraceful ignorance of the Bible in their writings; nor can the most acute of them
compare, for sense and judgment, with the most ordinary of modern commentators. The
whole course of Patristic theology affords abundant instances of the very low powers of
these writers, for the discrimination of truth and falsehood. The science of historical criticism
had no existence among them――nor indeed is there any reason why they should be
considered persons of any historical authority, except so far as they can refer directly to the
original sources, and to the persons immediately concerned in the events which they
record. On all matters of less unexceptionable authority, where their testimony does not
happen to contradict known truth or common sense, all that can be said in their favor, is,
that the thing thus reported is not improbable; but all supplements to the accounts given in
the New Testament, unless they refer directly to eye-witnesses, may be pronounced very
suspicious and wholly uncertain. In this case, Eusebius’s opinion that James, the brother of
our Lord was the son of Joseph, is worth no more than that of the latest commentator;
because he had no more historical aids than the writers of these days. Nor is the story of
Clemens, that James was bishop of Jerusalem, worth any more; because he does not refer
to any historical evidence.
his epistle.
Noticing some peculiar circumstances in the condition of his

countrymen, throughout this wide dispersion, the apostle addressed
to them a written exhortation, suited to their spiritual necessities. In
the opening, he announces himself simply by the title of “James, the
servant of Jesus Christ,” not choosing to ground any claim for their
respect or obedience on the accidents of birth or relationship, but on
the mere character of one devoted to the cause of Christ for life and
for death,――and entitled, by the peculiar commission of his Lord, to
teach and direct his followers in his name. In consequence of this
omission of the circumstance of relationship, a query has been even
raised whether the author of this epistle could really be the same
person as the brother of Jesus. But a trifle of this kind can never be
allowed to have any weight in the decision of such a question. He
directs himself, in general terms, to all the objects of his extended
apostolic charge;――“to the twelve tribes that are in the Dispersion.”
A brief review of the contents of the epistle will furnish the best
means of ascertaining its scope and immediate object, and will also
afford just ground for tracing the connection, between the design of
the apostle and the remarkable events in the history of those times,
which are recorded by the other writers of that age. He first urges
them to persevere in faith, without wavering or sinking under all the
peculiar difficulties then pressing on them; and refers them to God as
the source of that wisdom which they need for their direction. From
him alone, all good proceeds; but no sin, nor temptations to sin. The
cause of that, lies in man himself: let him not then blasphemously
ascribe his evil dispositions nor the occasions of their development,
to God; but seeking wisdom and strength from above, let him resist
the tempter:――blessed is the man that thus endures and
withstands the trial. He next points out to them the utter
worthlessness of all the distinctions of rank and wealth among those
professing the faith of Jesus. Such base respect of persons on the
score of accidental worldly advantages, is denounced, as being
foreign to the spirit of Christianity. True religion requires something
more than a profession of faith; its substance and its signs are the
energetic and constant practice of virtuous actions, and it allows no
dispensations or excuses to any one. He next dwells especially on
the high responsibilities of those who assume the office of teaching.
The tongue requires a most watchful restraint, lest passion or haste
pervert the advantages of eminence and influence, into the base
instruments of human wrath. The true manifestations of religious
knowledge and zeal, must be in a spirit of gentleness, forbearance,
and love,――not in the expressions of hatred, nor in cursing. But of
this pure, heavenly spirit, their late conduct had shown them to be
lamentably destitute. Strifes, tumults, and bitter denunciations, had
betrayed their un-Christian character. They needed therefore, to
humbly seek this meek spirit from God, and not proudly to assume
the prerogatives of judgment and condemnation, which belonged to
Him alone. His condemnation was indeed about to fall on their
country. With most peculiar ruin would it light on those now reveling
in their ill-gotten riches, and rejoicing in the vain hope of a perpetual
prosperity. But let the faithful persevere, cheered by the memory of
the bright examples of the suffering pious of other days, and by the
hope of the coming of their Lord, whose appearance in glory and
judgment, would soon crown their fervent prayers. Meanwhile,
supported by this assurance, let them continue in a virtuous course,
watching even their words, visiting the sick in charity and mercy, and
all exhorting and instructing each other in the right way.
The peculiar difficulties of the times here referred to, are――a

state of bloody intestine commotion, disturbing the peace of society,
and desolating the land with hatred, contention and murder;――a
great inequality of condition, in respect to property,――some
amassing vast wealth by extortion, and abusing the powers and
privileges thereby afforded, to the purposes of
tyranny,――condemning and killing the just;――a perversion of laws
for the gratification of private spite;――and everywhere a great
occasion for good men to exercise patience and faith, relying upon
God alone, for the relief of the community from its desperate
calamities. But a prospect was already presented of a consummation
of these distracting troubles, in the utter ruin of the wicked; a change
in the condition of things was about to occur, which would bring
poverty and distress upon the haughty oppressors, who had heaped
treasure together only for the last days. The brethren therefore, had
but a little time to wait for the coming of the Lord. Both of these two
latter expressions point very clearly at the destruction of
Jerusalem,――for this is the uniform reference which these terms
had, in those days, among the Christians. Jesus had promised his
chosen disciples, that their generation should not pass away, till all
those awful calamities which he denounced on the Jewish state,
should be fulfilled; and for this event all his suffering followers were
now looking, as the seal of the truth of Christ’s word. Searching in
the history of the times, a few years previous to that final desolation,
it is found in the testimony of impartial writers, that these were the
too faithful details of the evils which then raged in Palestine. “For,
under Felix, and again under Portius Festus, desperate patriots
marched through the country, in whole bodies, and forcibly tore away
with them the inhabitants of open places, and if they would not follow
them, set fire to the villages, and enacted bloody scenes. They even
made their appearance in the capital and at the feasts, where they
mixed among the crowd of people, and committed many secret
assassinations with concealed weapons. As to that which regards
the external circumstances and the civil condition of the Jews and
Jewish Christians, they were far from being agreeable. The praetors,
under all manner of pretexts, made extortions, and abused their legal
authority for the sake of enriching themselves; a person was obliged
to purchase with money his liberation from their prisons, as well as
his safety and his rights; he might even purchase a license to commit
crimes. In this state, under these circumstances, and in this degree
of civil disorder, the author might probably have regarded his
countrymen; for, although he wrote to the whole world, yet his native
land passed more immediately before his eyes.”
For the sources, and for the minuter proofs and illustrations of these views, see Hug’s
Introduction, as translated by Wait, Vol. II. §§ 148‒159.
In the immediate consideration of all these present iniquities and

coming desolations, he wrote to prepare the believing Jews, in
Palestine more particularly, but also throughout the world, for the
overwhelming consummation of their nation’s destiny. Terrible as
would be this doom, to the wicked, and mournful as would be these
national desolations, to all, the righteous should find consolations in
the peaceful establishment of the spiritual kingdom of their Lord,
over the ruins of the dominion of his murderers,――of those who
had “condemned and killed the just One, though he did not resist
them.” But in all these awful signs, should the faithful see the
forewarned coming of the Son of Man; and as he himself told his
chosen apostles, “then should they lift up their heads; for their
redemption drew nigh.”
Besides these external troubles, there were others of a different

character, arising and existing solely among those who professed
the religion of Christ. The instructions given by Paul, in reference to
the absolute necessity of faith, and the insufficiency of a mere formal
routine of religious duties, had been most grossly perverted into a
warrant for the all-sufficiency of a mere belief, as the means of
salvation;――an error by no means limited in its mischievous
existence, to the days of the apostles, but so comfortable to the
minds of mere religious formalists, in all ages of Christianity, that a
new revelation, like that here made by James, though directly
repeated through every century of the Christian era, would be
equally vain, for the prevention or the remedy of this never-dying
heresy. All the words of James on the subject of faith and works, are
evidently aimed at the refutation of those who had taken advantage
of the opinions which Paul had expressed, on the same subjects; but
which were expressed with a totally different reference, being stated
not generally nor abstractly, but in application to some particular
dogmatic errors. James, after distinctly condemning the “unlearned
and unstable, who thus wrested to their own destruction the things
hard to be understood in the writings of Paul,” next attacks certain
persons who, without being authorized or qualified, had assumed the
station and responsibility of religious teachers. Many persons taking
up the office of instructors in this manner, had caused great
confusion, by using their hasty tongues, in mere polemic and
denunciatory discourse, condemning and cursing, in unmeasured
terms, those who differed from them in opinion. These he rebukes,
as thus “giving occasion for offense and error to all;” and sets forth
the character of that true wisdom which comes from above, and
which is peaceable, “sowing the fruit of righteousness in peace.”
Many teachers. In order to understand this reference, it should be noticed that the word
masters in the common translation of chap. iii. verse 1, of this epistle, is not to be taken in
the common modern sense, but in that of “religious teachers.” The original is not Κυριοι
(Kurioi,) “Lords,” “Masters,”――but διδασκαλοι (didaskaloi,) “teachers.” The translators
probably intended it only in the latter sense; for the word “Master” really has that meaning in
such connections, in good authors of that age; and even at this day, in England, the same
usage of the word is very common, though almost unknown in this country, except in
technical phrases.
his death.
The epistle was probably the last great act of his life. No record,
indeed, of any of his labors, except this living instance, exists of his
later years; but there is certain ground for supposing that his
residence in Jerusalem was characterized by a steady course of
apostolic labors, in the original sphere of action, to which the twelve
had first confined themselves for many years. When, by the special
calls of God, in providences and in revelations, one and another of
the apostles had been summoned to new and distant fields, east,
west, north and south, “preaching repentance and remission of sins,
in his name, among all nations, beginning at Jerusalem,” and
bearing witness of his works, thence, “through Judea, and Samaria,
and unto the uttermost part of the earth,” there was still needed one,
who, highly “indued with power from on high,” might remain in that
city to which all the sons of Israel, throughout the world, looked as
the fountain of religious light. There too was the scene of the first
great triumphs of the Christian faith, as well as of the chief toils, the
trials, and the death of the great founder himself. All these
circumstances rendered Jerusalem still an important post to the
apostles; and they therefore left on that station the apostle, whose
steady courage in the cause of Christ, and blameless yet jealous
conformity to the law of Moses, fitted him at once for the bold
maintenance of his Master’s commission, and for the successful
advancement of the gospel among the faithful believers of the
ancient covenant. Thus James continued at Jerusalem throughout
his life, being kept at this important station, perhaps on account of
his age, as well as for his fitness in other respects; as there is some
reason to think that he was older than those more active apostles
who assumed the foreign departments of the work. His great weight
of character, as evinced in the council of the apostles, and by the
fear which Peter showed of offending him, very naturally gives the
idea of a greater age than that of the other apostles; and this notion
is furthermore confirmed by the circumstance that the brethren of
Jesus, among whom this apostle was certainly included, are
mentioned as assuming an authority over their divine relation, and
claiming a right to control and direct his motions, which could never
have been assumed, according to the established order of Jewish
families, unless they had been older than he. It is therefore a rational
supposition, that James was one of the oldest, perhaps the oldest, of
the apostles; and at any rate he appears to have been more
advanced in life than any of those who are characterized with
sufficient distinctness to offer the means of conjecture on this point.
From the high charge of this great central apostolic station, in

which he had, through a course of more than twenty-five years,
accumulated the ripe honors of a “righteous” name upon his hoary
head, James was now called to end a career, which so much
resembled that of the ancient prophets, by a death equally
assimilated to the bloody fate to which so many of them had been
doomed by the subjects of their reproofs. The fact and
circumstances of his death are given on an authority so blameless
and disinterested as not to admit of dispute; nor is there any thing in
the narrative which can throw the slightest suspicion upon it. The
eminent Jewish historian, Josephus, himself a resident in Jerusalem
at that time, and an eye-witness of these events, and acquainted by
sight and fame, at least, with James, has given a clear account of
the execution of this apostle, which can best evince its own merit by
being given entire.
The account which Josephus has given, shows that the death of
James, must have happened during Paul’s imprisonment, and is
delivered in the following words:――“The emperor, being informed of
the death of Festus, sent Albinus to be prefect of Judea. But the
younger Ananus, who, as we said before, was made high priest, was
haughty in his behavior, and very ambitious. He was also of the sect
of the Sadducees, who, as we have also observed before, are above
all other Jews severe in their judicial sentences. This then being the
temper of Ananus, he, thinking he had a convenient opportunity,
because Festus was dead, and Albinus was not yet arrived, called a
council, and brought before it James, brother of Jesus, who was
called Christ, with several others, where they were accused of being
transgressors of the law, and stoned to death. But the most
moderate men of the city, who were also the most learned in the
laws, were offended at this proceeding. They sent therefore privately
to the king, and entreated him to give orders to Ananus to abstain
from such conduct in future. And some went to meet Albinus, who
was coming from Alexandria, and represented to him, that Ananus
had no right to call a council without his permission. Albinus,
approving of what they said, wrote a very severe letter to Ananus,
threatening to punish him for what he had done. And king Agrippa
took away from him the priesthood, after he had possessed it three
months, and appointed in his stead Jesus, the son of Damnaeus.”
From this account of Josephus we learn, that James,
notwithstanding he was a Christian, was so far from being an object
of hatred to the Jews, that he was rather beloved and respected. At
least his death excited very different sensations from that of the first
James; and the Sadducean high priest, at whose instigation he
suffered, was punished for his offense by the loss of his office.
This translation is taken from Marsh’s Michaelis, (Introduction, Vol. IV. pp. 287, 288.) The
original is in the Jewish Antiquities of Josephus. (XX. ix. 1.)
This however, is not the statement which the early Christian

writers give of the death of James the Just; but from the oldest
historian of the church, is derived another narrative, so highly
decorated with minute particulars, that while it is made very much
more interesting than the concise and simple account given by
Josephus, it is at the same time rendered altogether suspicious by
the very circumstance of its interesting minuteness. Josephus had
no temptation whatever to pervert the statement. He gives it in terms
strongly condemnatory of the whole transaction; but the Christian
writers, as they have shown in other such instances, are too often
disposed to sacrifice truth, for the sake of making a story whose
incidents harmonize best with their notions of a desirable martyrdom.
The story however, deserves a place here, both for the sake of a fair
comparison, and on account of its own interesting character.
“James, the brother of our Lord, surnamed the Just, was holy from
his mother’s womb. He drank neither wine, nor strong drink; nor ate
any creature wherein was life. There never came a razor upon his
beard;――he anointed not himself with oil, neither did he use a bath.
To him only it was lawful to enter into the holy of holies. He wore no
woolen, but only linen garments; and entered the temple alone,
where he was seen upon his knees, supplicating for the forgiveness
of the people, till his knees became hard, and covered with a callus,
like those of a camel. On account of his eminent righteousness, he
was called the Just, and Oblias, which signifies ‘the people’s
fortress.’ Then, after describing the divisions among the people
respecting Christianity, the account states, that all the leading men
among the Scribes and Pharisees, came to James, and entreated
him to stand up on the battlements of the temple, and persuade the
people assembled at the passover, to have juster notions concerning
Jesus; and that, when thus mounted on the battlements, he cried
with a loud voice, ‘Why do ye question me about Jesus, the Son of
Man? He even sits in heaven, at the right hand of great power, and
will come in the clouds of heaven.’ With this declaration, many were
satisfied, and cried ‘Hosanna to the Son of David.’ But the
unbelieving Scribes and Pharisees, mortified at what they had done,
produced a riot; for they consulted together, and then cried out, ‘Oh!
oh! even the Just one is himself deceived.’ They went up, therefore,
and cast down the Just, and said among themselves, ‘Let us stone
James the Just.’ And they began to stone him, for he did not die with
his fall; but turning, he kneeled, saying, ‘I entreat, O Lord God the
Father, forgive them, for they know not what they do.’ And while they
were stoning him, one of the priests, of the sons of Rahab, spoken of
by Jeremiah the prophet, cried out, ‘Cease; what do ye? Justus
prays for us.’ But a certain one among them, a fuller, took a lever,
such as he had used to squeeze garments, and smote Justus on the
head. Thus he suffered martyrdom; and they buried him in that
place, and his grave-stone yet remains near the temple.”
This story is from Hegesippus, as quoted by Eusebius, to whom alone we owe its
preservation,――the works of the original author being all lost, except such fragments,
accidentally quoted by other writers. The translation I have taken from the MS. of the Rev.
Dr. Murdock, to whose research I am already so much indebted in similar instances.
The comments of Michaelis on these two testimonies, may be appropriately subjoined.

(Introduction, Vol. IV. pp. 288, 291. Marsh’s translation.)
“The account given by Hegesippus, contains an intermixture of truth and fable; and in
some material points contradicts the relation of Josephus, to ♦which no objection can be
made. It confirms however the assertion, that James was in great repute among the Jews,
even among those who did not believe in Christ; and that they paid him much greater
deference than we might suppose they would have shown to a Christian bishop, and a
brother of Christ, whom they had crucified. Many parts of the preceding account are
undoubtedly fabulous, especially that part which relates to the request of the Jews, that
James would openly declare from the battlements of the temple, that Jesus was not the
Messiah. Indeed, if this were true, it would not redound to his honor; for it would imply that
he had acted with duplicity, and not taken a decided part in favor of Christianity, or the Jews
could never have thought of making such a request. But that a person, who was the head of
the church in Jerusalem, should have acted such a double part as to leave it undecided
what party he had embraced, and that too for thirty years after the ascension, is in itself
almost incredible. It is inconsistent likewise with the relation of Josephus, and is virtually
contradicted both by Paul and by Luke, who always speak of him with the utmost respect,
and have no where given the smallest hint, that he concealed the principal doctrines of the
Christian religion.”
♦ “whieh” replaced with “which”
Thus gloriously ended the steady, bright career of “the second

apostolic martyr.” Honored, even by the despisers of the faith and
haters of the name of Christ, with the exalted title of “the just,” he
added the solemn witness of his blood, to that of his divine brother
and Lord, and to that of his young apostolic brother, whose name
and fate were equally like his,――a testimony which sealed anew
the truth of his own record against the sins of the oppressors,
published in his last great earthly work:――“Ye have condemned
and killed the just; yet he doth not resist you.”
SIMON ZELOTES.
his name.
The ever-recurring difficulty about the distinctive appellations of

the apostles, forms the most prominent point of inquiry in the life of
this person, otherwise so little known as to afford hardly a single
topic for the apostolic historian. The dispute here indeed involves no
question about personal identity, but merely refers to the coincidence
of signification between the two different words by which he is
designated in the apostolic lists, to distinguish him from the illustrious
chief of the twelve, who bore the same name with him. Matthew and
Mark in giving the names of the apostles,――the only occasion on
which they name him,――call him “Simon the Cananite;” but Luke, in
a similar notice, mentions him as “Simon Zelotes;” and the question
then arises, whether these two distinctive appellations have not a
common origin. In the vernacular language of Palestine, the word
from which Cananite is derived, has a meaning identical with that of
the root of the Greek word Zelotes; and hence it is most rationally
concluded, that the latter is a translation of the former,――Luke, who
wrote entirely for Greeks, choosing to translate into their language a
term whose original force could be apprehended only by those
acquainted with the local circumstances with which it was connected.
The name Zelotes, which may be faithfully translated by its English
derivative, Zealot, has a meaning deeply involved in some of the
most bloody scenes in the history of the Jews, in the apostolic age.
This name, or rather its Hebrew original, was assumed by a set of
ferocious desperadoes, who, under the honorable pretense of a holy
zeal for their country and religion, set all law at defiance, and
constituting themselves at once the judges and the executors of
right, they went through the land waging war against the Romans,
and all who peacefully submitted to that foreign sway. This sect,
however, did not arise by this name until many years after the death
of Jesus, and there is no good reason to suppose that Simon derived
his surname from any connection with the bloody Zealots who did
their utmost to increase the last agonies of their distracted country,
but from a more holy zeal displayed in a more righteous manner. It
may have been simply characteristic of his general conduct, or it
may have referred to some particular occasion in which he decidedly
evinced this trait of zeal in a righteous cause.
The Cananite.――In respect to this name, a most absurd and unjustifiable blunder has
stood in all the common versions of it, which deserves notice. This is the representation of
the word in the form, “Canaanite,” which is a gross perversion of the original. The Greek
word is Κανανιτης, (Kananites,) a totally different word from that which is used both in the
New Testament, and in the Alexandrian version of the Old, to express the Hebrew term for
an inhabitant of Canaan. The name of the land of Canaan is always expressed by the
aspirated form, Χανααν, which in the Latin and all modern versions is very properly
expressed by “Chanaan.” In Matthew xv. 22, where the Canaanitish woman is spoken of,
the original is Χαναναια, (Chananaia,) nor is there any passage in which the name of an
inhabitant of Canaan is expressed by the form Κανανιτης, (Cananites,) with the smooth K,
and the single A. Yet the Latin ecclesiastic writers, and even the usually accurate Natalis
Alexander, express this apostle’s name as “Simon Chananaeus,” which is the word for
“Canaanite.”
The true force and derivation of the word is this. The name assumed in the language of
Palestine by the ferocious sect above mentioned, was derived from the Hebrew primitive ‫קנא‬
(Qana or Kana,) and thence the name ‫( קנני‬Kanani) was very fairly expressed, according to
the forms and terminations of the Greek, by Κανανιτης, (Kananites.) The Hebrew root is a
verb which means “to be zealous,” and the name derived from it of course means, “one who
is zealous,” of which the just Greek translation is the word Ζηλωτης, (Zelotes,) the very
name by which Luke represents it in this instance. (Luke vi. 15; Acts i. 13.) One of these
names is, in short, a mere translation of the other,――nor is there any way of evading this
construction, except by supposing that Luke was mistaken in supposing that Simon was
called “the Zealot,” being deceived by the resemblance of the name “Cananites” to the
Hebrew name of that sect. But no believer in the inspiration of the gospel can allow this
supposition. Equally unfounded, and inconsistent with Luke’s translation, is the notion that
the name Cananite is derived from Cana the village of Galilee, famous as the scene of
Christ’s first miracle.
The account given in the Life of Matthew shows the character of this sect, as it existed in
the last days of the Jewish state. Josephus describes them very fully in his history of the
Jewish War, (iv. 3.) Simon probably received this name, however, not from any connection
with a sect which arose long after the death of Christ, but from something in his own
character which showed a great zeal for the cause which he had espoused.
his history.
No very direct statement as to his parentage is made in the New
Testament; but one or two incidental allusions to some
circumstances connected with it, afford ground for a reasonable
conclusion on this point. In the enumeration which Matthew and
Mark give of the four brothers of Jesus, in the discourse of the
offended citizens of Nazareth, Simon is mentioned along with
James, Juda and Joses. It is worthy of notice, also, that on all the
apostolic lists, Simon the apostle is mentioned between the brothers
James and Juda; an arrangement that can not be accounted for,
except by supposing that he was also the brother of James. The
reason why Juda is distinctly specified as the brother of James, while
Simon is mentioned without reference to any such relationship, is,
doubtless, that the latter was so well known by the appellation of the
Zealot, that there was no need of specifying his relations, to
distinguish him from Simon Peter. These two circumstances,
incidentally mentioned, may be considered as justifying the
supposition, that Simon Zelotes was the same person as Simon the
brother of Jesus. In this manner, all the old writers have understood
the connection; and though such use is no authority, it is worth
mentioning that the monkish chroniclers always consider Simon
Zelotes as the brother of Juda; and they associate these two, as
wandering together in eastern countries, to preach the gospel in
Persia and Mesopotamia. Others carry him into much more
improbable wanderings. Egypt and Northern Africa, and even Britain,
are mentioned as the scenes of his apostolic labors, in the ingenious
narratives of those who undertook to supply almost every one of the
nations of the eastern continent with an apostolic patron saint. All
this is very poor consolation for the general dearth of facts in relation
to this apostle; and the searcher for historical truth will not be so well
satisfied with the tedious tales of monkish romance, as with the
decided and unquestionable assurance, that the whole history of this
apostle, from beginning to end, is perfectly unknown, and that not
one action of his life has been preserved from the darkness of an
utterly impenetrable oblivion.

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Textbook Financial Risk Management Identification Measurement and Management 1St Edition Francisco Javier Poblacion Garcia Auth Ebook All Chapter PDF

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Financial Risk Management:

Identification, Measurement and

Winning with Risk Management Financial Engineering and

Financial Institutions Management: A Risk Management

Financial Risk Management Applications in Market Credit

Handbook of Financial Risk Management Chapman and Hall

Strategy, Value and Risk: Industry Dynamics and

Financial Cybersecurity Risk Management: Leadership

Rethinking Risk in National Security: Lessons of the

Marketplace lending financial analysis and the future

Francisco Javier Población García

ISBN 978-3-319-41365-5 ISBN 978-3-319-41366-2 (eBook)

Library of Congress Control Number: 2016958311

© The Editor(s) (if applicable) and The Author(s) 2017

Cover image © Maciej Bledowski / Alamy Stock Photo

Printed on acid-free paper

This Palgrave Macmillan imprint is published by Springer Nature

Part I Introduction and Perspectives 1

2.1.2.1 Greek Letters 25

Part II Market Risk 39

3 One-Dimensional Market Risk; Equity Risk 41

3.5 VaR Applications 69

4 Multidimensional Market Risk 75

5 Interest Rate Risk 101

5.2 The Term Structure of Interest Rates 108

6 Exchange Rate Risk 135

7 Price Risk in Commodities 155

7.2 Commodity Price Dynamics 162

8 Market Risk Hedging 171

Part III Credit Risk 199

9 Credit Risk: Measurement 201

9.2 Measuring Credit Risk 206

10 Credit Risk: Validation 235

11 Credit Risk Management 249

11.3 Hedging with Derivatives 257

12 Derivative Credit Risk (Counterparty Risk) 265

Part IV Other Risks 275

13 Operational Risk 277

14 Liquidity Risk 293

14.2 Liquidity Risk Measurement 295

15 Country Risk 305

Part V Financial Implications of Risk 321

16 The CAPM 323

16.2.2.2 Analytic Derivation of the

17 The WACC 345

Glossary of Terms 359

Fig. 1.1 Corporate risk management, business strategy and ﬁnancial

Fig. 3.10 Probability distribution of the portfolio value at t ¼ 1

Table 3.1 Aggregation 44

Table 16.2 Variance–covariance matrix (Author’s own composition) 328

1.1 General Principles

© The Author(s) 2017 3

thing that has to be done to analyse a company’s risk is to deﬁne some

1.1.2 The Purpose of Corporate Risk Management: The

The purpose of a business is to develop economic activity and this involves

have for certain risk proﬁles. Financial statements collect information

1.1.3 Cost–Beneﬁt Analysis

Obviously, in order to modify the natural risk proﬁle of a company, there

♦ “accomodation” replaced with “accommodation”

The great eminence of James among the apostles is very fully

But no where is his eminence among the apostles so strongly

♦ “Jerasalem” replaced with “Jerusalem”

his apostolic office.