PeopleSoft Enterprise Risk Management 9.1 PeopleBook

Analyzing Risk

This chapter provides an overview of the risk analysis process and discusses how to:

Run and maintain VaR analysis.
Export market risk files.

Understanding the Risk Analysis Process

This section discusses:

Prerequisites.
Common elements used in this chapter.
Provided valuation functions.

Prerequisites

You must first define risk analytics on the Instrument Analytics page.

Common Elements Used in This Chapter

Calculation or Analytic Calculation	Select a calculation to generate the risk analysis. The selected vendor or vendor product name determines the available values.
Function Usage	Select the type of analysis to perform.
Mode or Analytics Mode	Available values depend on the function usage type.
Vendor or Vendor Product Name	Select from the available vendor names, for example,Excel Functions. You define vendor names and their analytic calculations at installation.
Calculate	Click to run a risk analysis calculation.

Provided Valuation Functions

Analytics calculation includes all of the different functions needed to perform a comprehensive risk analysis and management. For example, due to the complexity of analysis and companies, you can create your own customized analytics. Customized analytics include:

Analytics calculation.
Treasury deal valuations.
Cash forecasting.
Sales forecast.
Manufacturing optimization.
Brand and channel valuation.
Macro level analysis
Hedging effectiveness.
Value at Risk (VaR).

Use combinations of different exposure objects to evaluate the impact of business and financial risks on the enterprise. Currently, exposure objects (treasury and non-treasury) are defined stored.

Graphs and reports.

The system stores analysis and analytic activity output. You can generate reports (system delivered or customized) for both managerial and compliance needs, which consist of online analytical processing (OLAP) and generic data.

Here's how to determine hedges:
Process and analyze a current cash position worksheet.
Process and analyze VaR risk calculations.
Determine what deals must be hedged from analysis results.

Analyzing VaR

This section provides an overview of VaR analysis and discusses how to run VaR analysis.

Understanding VaR Analysis

VaR is a methodology for measuring financial risk exposure. VaR is a number that represents estimated portfolio losses due to market movements for a particular time period and a given confidence level. With VaR, you can identify sources of risk and either bear them to support long-term strategies, transfer the risks at a reasonable price, or decide on alternatives to shed the risk.

Defining potential loss depends on two parameters:

Time horizon considerations.
Degree of confidence.

Time Horizon Considerations

Choosing a horizon for VaR calculation depends on your company's objectives and the portfolio's characteristics. Typical considerations include:

Unwind period: how long, on average, does it take to reverse a market position or individual trade?
Attention period: how often, on average, do you reexamine your portfolio and its mark-to-market or hedging trades?
Accounting period: how long until the next financial reporting must be done?

Degree of Confidence (Probability of Occurrence)

The degree of confidence is a measure of the degree of certainty of the VaR estimate. The most commonly used degree of confidence is 95 percent, which means that 95 percent of the time the losses will be lower than the VaR number, while 5 percent of the time the portfolio will experience greater losses.

For example, an enterprise's Relative Earnings at Risk (EaR) are 10.00 MM USD, the time period is set to three months, and the confidence level is 95 percent. Over the next three months, there is a five percent chance that earnings will fall 10.00 MM USD or more below the target earnings for the period (6.00 MM USD).

Note. VaR concentrates on financial price risk, not on operational, legal, and other risks that the enterprise faces.

Calculating VaR

You can calculate VaR from three complementary methodologies and use these different measurements to simultaneously provide an overall view of your portfolio's risks.

Variance-covariance (analytic VaR)	The most commonly used of the three VaR methods, variance-covariance analyzes volatility and correlation between different risk exposures of an enterprise's portfolio.
Monte Carlo simulation	Generates random scenarios of prices and uses them to reevaluate a portfolio. Looking at hypothetical profits and losses under each price scenario, you can construct a histogram of expected profit and losses from which VaR is calculated. It does not assume that portfolio returns are distributed normally, but you need a correlation and volatility matrix to generate the random scenarios.
Historical simulation	Revalues a portfolio for several hundred historical scenarios, building a "hypothetical" distribution of profit and losses based on how the portfolio behaved in the past. It does not use estimated variances and covariances and does not make any assumptions about the distribution of the portfolio returns. Results can be skewed by anomalous events of a previous period. A few major events in the past may dominate the simulation exercise, so your analysis is then based on fewer data points.

Page Used to Run VaR Analysis

Page Name	Definition Name	Navigation	Usage
VaR Analysis	RSK_VAR_RUN_PNL	Risk Management, Analyze Risk, VaR Analysis, VaR Analysis	Enter analytical parameters and calculate VaR on your portfolios.

Running VaR Analysis

Access the VaR Analysis page (Risk Management, Analyze Risk, VaR Analysis, VaR Analysis).

Vendor

Select a third-party vendor that will perform the VaR calculation based on the input values selected on this page. The vendor selected here determines the values available in the Calculation field.

Calculation

Select the type of VaR calculation to be performed. The calculation value selected here determines which functions from the MTM_DATAMAP_WRK.FUNLIB_02 function library are used to call the vendor to perform the calculation

File Path

Specify the output location of the log file for this vendor.

VaR Method

Select from the following options:

Analytic: Estimation of the volatility of asset returns and of the correlations between these asset price movements.

Historical: Consists looking back over a specific period of time and applying current weights to a time-series of historical asset returns. This return does not represent an actual portfolio but rather reconstructs the history of a hypothetical portfolio using the current position.

Monte Carlo: The Monte Carlo method is a two-step process:

The risk manager specifies a stochastic process for financial variables, as well as process parameters; the choice of distributions and parameters such as risk and correlations can be derived from historical data.

Fictitious price paths are simulated for all variables of interest. At each horizon considered, which can go from one day to many months ahead, the portfolio is marked-to-market using full valuation. Each of these scenarios are then used to compile a distribution of returns, from which a VaR figure can be measured.

Calculate

Click to run the VaR calculation.

VaR

Displays the results of the specified VaR calculation.

Exporting Market Risk Files

Using the Risk File Export process (RSK_FILEXP), you can export risk analysis data for a specified business unit and portfolio to a third party.

Page Used to Export Market Risk Files

Page Name	Definition Name	Navigation	Usage
Export Market Risk File	TR_FOUR15_FILE_EXP	Risk Management, Analyze Risk, Export Market Risk File, Export Market Risk File	Run the Risk File Export application engine process to export risk analysis files to a third-party application.

Exporting Market Risk Files

Access the Export Market Risk File page (Risk Management, Analyze Risk, Export Market Risk File, Export Market Risk File).

Unit

Select a business unit. The business unit selected determines the prompt values for the portfolio and instrument type fields.

Portfolio

Select a portfolio to determine which deals will be included in the file.

Instrument Type

Selecting an instrument type will limit the inclusion of file data to only deals of a particular instrument type. This field can be left blank.

File Path

Enter the path and directory to which the newly created file will be exported.

Vendor	Select a third-party vendor that will perform the VaR calculation based on the input values selected on this page. The vendor selected here determines the values available in the Calculation field.
Calculation	Select the type of VaR calculation to be performed. The calculation value selected here determines which functions from the MTM_DATAMAP_WRK.FUNLIB_02 function library are used to call the vendor to perform the calculation
File Path	Specify the output location of the log file for this vendor.
VaR Method	Select from the following options: Analytic: Estimation of the volatility of asset returns and of the correlations between these asset price movements. Historical: Consists looking back over a specific period of time and applying current weights to a time-series of historical asset returns. This return does not represent an actual portfolio but rather reconstructs the history of a hypothetical portfolio using the current position. Monte Carlo: The Monte Carlo method is a two-step process: The risk manager specifies a stochastic process for financial variables, as well as process parameters; the choice of distributions and parameters such as risk and correlations can be derived from historical data. Fictitious price paths are simulated for all variables of interest. At each horizon considered, which can go from one day to many months ahead, the portfolio is marked-to-market using full valuation. Each of these scenarios are then used to compile a distribution of returns, from which a VaR figure can be measured.
Calculate	Click to run the VaR calculation.
VaR	Displays the results of the specified VaR calculation.

Unit	Select a business unit. The business unit selected determines the prompt values for the portfolio and instrument type fields.
Portfolio	Select a portfolio to determine which deals will be included in the file.
Instrument Type	Selecting an instrument type will limit the inclusion of file data to only deals of a particular instrument type. This field can be left blank.
File Path	Enter the path and directory to which the newly created file will be exported.