ABSTRACT
Being a bond portfolio manager, having significant investment in debt instruments, it is very crucial for him/her to successfully measure and manage all concerned risks that the portfolio is exposed to. Successful management of any such risks largely depends upon the use of proper risk measurement tools and techniques and therefore quantifying the volume or magnitude of the concerned risks in a robust manner. Quantification or measurement of risks, especially in abnormal/stress market scenario becomes very challenging to the portfolio/risk manager. The objective of this chapter is to make the readers well versed with the Scope, Practices, and Approaches of measuring and managing concerned risks, especially interest rate and credit risk, lies in fixed income portfolios. This chapter discusses the common (Standard and Advanced) tools and techniques primarily to quantify the interest rate risk, followed by the ways to manage them, especially in the context of banking. At the end of this chapter, the readers are expected to be familiar with:
Overview of Risk Management Practices, especially Market Risk, applicable for banks and other financial institutions.
Identification of major risks in fixed income securities, with special reference to fixed income market in emerging economies.
Methods or Approaches (Standard and Advanced) to quantify the interest rate risks, affecting investment in fixed income securities to a large extent.
Use of different methods (VCV, HS, MCS) to estimate the Value at Risk (VaR), especially of a bond portfolio.
Impact of using Sensitivity based measures (M-Duration, PV01) verses Simulation based measures (Value at Risk – VaR, Expected Shortfall – ES) in quantifying the interest rate risk of a bond portfolio.
Conducting Back Testing and Stress Testing exercise to ensure a robust risk measurement and management system.
Regulatory approach, in the context of commercial banking, to manage the major risks in fixed income portfolio by way of estimating the necessary Capital Charges, depending on the selected risk measurement techniques, and their impact on the overall business of the concerned institution.
