Библиографическое описание:

Иванова Н. М., Лалыкина А. Д. Risks and risk management tools in securities market // Молодой ученый. — 2016. — №11. — С. 759-763.

Securities market plays an important role in the modern economy. More and more people tend to start to work in the securities market, but their activity is associated with a greater risk.

Circulation of securities is a complex process that involves many professionals of the stock market. Potentially higher returns can be obtained only by taking on greater risk and share. Many investors do not resort to such practice. Most individuals tends completely or partly eliminate the risk. For the organization of the process of circulation of securities it is necessary to have the existence of a developed network of specialized licensed institutions, perfect regulatory framework, skilled certified professionals. In particular it is important to guarantee the safety of the process, to minimize the risks.

The problem of our paper is that in a market economy the commodity price changes, the security price changes, changes in interst rate always occur. Due to these facts the participants of the securities market risk of loss of money, so they try to forecast the future situation and insure their activities, by minimizing risks and using special types of hedging.

The goal is an identification of potential risks, which occur in the securirties market and the management of these risks.

The tasks are the following:

– Consider the classification of risks

– Identify methods of risk assessment

– Determine the methods of risk management

Risk is defined as the probability of unfavorable event multiplied by the severity of harm, if the event occurs. The financial risks associated with transactions in securities is the probability of losses due to the high degree of uncertainty of the results and the impact on them of the set of economic and non-economic factors, including random.

Losses as a result of the financial risks in securities transactions may occur in various forms:

– Direct financial losses (e.g. security, bought at a high price, cannot be realized without a loss in the event of a fall of its market value)

– Loss of profit (e.g. an investor rather than to buy a stock that showed high growth in the future market value, leave the money in the current account in the bank)

– Reduced profitability (e.g. in the case of purchase of bonds with a «floating» coupon,when market interest rates decrease).

The risks are classifies on various grounds:

  1. by sources of risks, and
  2. by risk factors.

By sources of risks there are several types exist. For instance, Asystem (market) risk is a probability of losses due to falling market securities in general. This type of risk is not associated with any particular security, it is common to all investments in securities. An investor cannot in affect on the estimations of this risk, reduce it, so systemic risk is nondiversifiable and not lowered. Of course, over time, this risk may change as a result of stabilization of the economic situation, the development of production and so on, but at this particular point of time the value of this risk is not possible to change. In assessing system risk, the investor can make only two solutions: to work in the securities market or go into another field for investment (in the real estate market, the currency market, the market precious metals, etc.). [1]

Non-system or specific risk is the probability of losses in connection with transactions with specific securities (portfolio), it is a generic concept characterizing all kinds of risks associated with particular securities. This risk is not directly related to market conditions, on the contrary, it is associated with the activity, market position, quality of management, but along with the system risk is a part of the overall risk of investments in securities.

Non-system risk is diversifiable andis possible to lower. This means that the investor, making the selection of securities that satisfy it in terms of risk, diversifying his investments (diversification of investments is the purchase of securities of different issuers, are not directly related to each other), can lower the value of this risk. Non-systemic risk includes the three risk groups: macroeconomic risks, risks of the enterprise (the issuer) and portfolio management risks and technical risks.

Industry risk is the risk of losses due to cash invested in the securities of a particular industry. Industry is estimated when assessing the financial risks associated with the securities. It takes into account two criteria: exposure to cyclical industries fluctuations and stage of the industry life cycle.

In terms of exposure to cyclical industries fluctuations emit:

– Branches heavily exposed to cyclical fluctuations (e.g. engineering),

– Branches slightly or not at all exposed to cyclical fluctuations (e.g. the production of consumer goods, food).

In terms of life cycle stages emit:

– The venture capital industries (e.g. Internet technology),

– Branches at the stage of steady growth (e.g. telecommunications),

– Branches in the mature stage of development (e.g. coal mining),

– Branches on the stage of extinction, dying branches (e.g. the coal industry).

The securities of the industry, caught in different groups to these classifications, differently manifest themselves in the market, have different levels of profitability, sensitivity to market fluctuations, different dynamics of the market value, and all these facts the investor must take into account when assessing the industry risk.

There is a following classification by risk factors:

Exchange rate risk is the probability of loss in investing in securities of foreign exchange due to unfavorable changes in foreign currency exchange rates in relation to the local currency.

Inflation risk is the risk of losses due to impairment of income from investments in securities as a result of inflation. An example of securities for which revenues are protected against inflation, can be indexed bonds issued by the government of England. Fixed real 2 percent rate means that the income of 2 % will be paid not by the nominal bonds, but by the nominal, indexed in accordance with the growth of retail prices, which in the UK is published monthly by the Ministry of Employment as an index of consumer prices, calculated on the basis of «consumer basket consisting of 600 items. [2]

Liquidity risk is a probability of losses due to falling of the market value of securities.

Interest rate risk is a probability of losses due to changes in market interest rates. This type of risk applies not only to investors but also to the issuers of securities.

Credit risk is a probability of losses due to the fact that the issuer can not meet its obligations to pay the principal amount of debt issued securities or interest on them. Credit risk refers only to those securities for which the issuer has fixed obligations, for instance, bonds, notes, certificates of deposit and savings banks, as well as preferred shares with a fixed dividend. Ordinary shares are not included, as Joint Stock Company is not required to pay dividends, for example, if there is no profit.

Macroeconomics' risks arise from factors acting at the level of overall economy, however, different securities differently reflect to the action of these factors.

Country Risk is the probability of losses due to investments in the securities of a particular country. The investor when assessing this risk, answers the question: whether it is worth investing in securities of that country?

Portfolio risk management and technical risk is the probability of losses due to wrong actions to manage the investment portfolio, as well as failures in the operating system. The loss of these risks can be very high, and now, when the use of computer technology and the Internet allows you to quickly transfer information to a huge number of users, the importance of technical errors increases many more. Here are some examples related to the implementation of these risks:

Risk of legislative changes is the probability of losses due to changes in legislation or the adoption of new, consequently, the position of the securities in the market changes.

Regional risk is a probability of losses due to cash invested in the securities of a particular region.

Enterprise Risk Management (Issuer) is the probability of losses due to the purchase of securities of a particular issuer (the issuer may be not only the enterprise, but also the state and municipalities). This group includes credit and interest rate risk, liquidity risk and the risk of fraud.

The risk of fraud is the probability of losses due to violations of the law, outright fraud, violation of the rights of shareholders.

Due to constant fluctuations in interest rates on the financial market, its participants have to try to reduce the impact of these fluctuations affecting their assets. It is possible to minimize risks by mechanisms of hedging, the most important of which will be discussed later in the work.

The first way to protect against interest rate risk is associated with financial instruments such as derivative securities (futures and options).

Futures are financial contracts obligating the buyer to purchase anasset(or thesellerto sell an asset), such as a financial instrument, at a predetermined future date and price. This agreement is made on the stock exchange. Futures can be used either tohedgeor to speculate on the price movement of the underlying asset. For example, a producer of corn could use futures to lock in a certain price and reduce risk (hedge). On the other hand, anybody could speculate on the price movement of corn by going long or short using futures.

Features of futures contracts:

– It is made on the stock exchange in accordance with the provisions adopted on it, so it is highly liquid.

– It is standard, so the investor can easily buy or sell a futures contract and subsequently liquidate its position by a reverse transaction.

– The conclusion of futures transactions is aimed not at real purchase, but at the sale of an asset and a hedge position or the game on the difference in price.

– Execution of a futures contract is guaranteed by a clearing house of the exchange.

The second method does not require the use of hedging tools. This method involves the selection of portfolio and firm commitments where the risk is protected against the changes in interest rate. This method is based on the concept of duration. [3]

The purpose of hedging is not to extract extra profits, but reducing the risk of potential losses from adverse changes in prices in the future.

Hedging on the stock exchange is carried out by enterprises, organizations and individuals that are in the same time participants of real goods market: producers, traders.

Hedging aims — to compensate losses due to the profit received from the sale of real goods on the market. It performs the function of an insurance from price losses on real goods market and provides compensation for certain expenses.

The most simple form of price risk insurance is the futures contracts.

When two parties agree to exchange any types of commodities in the future at a predetermined price, it is a forward contract. The side that agrees to purchase goods with the forward contract, takes so-called a long position, but the side that agrees to sell a product — takes a short position.

For example, it was planned to go from Boston to Tokyo in year and it is need to book a plane ticket. Airline employee offers to choose one of two options: either agree on a guaranteed ticket price of $ 1,000 now, or to pay for a ticket before departure.

In both cases, the payment will be made in the day of departure. If you choose an option with a guaranteed price in 1000 dollars, that means you make the forward contract with the airline.

By making a forward contract, we have eliminated the risk of having to pay for a ticket to more than $ 1,000. If in a year the ticket price will rise to $ 1,500, then we will be happy to have taken a decision and bought a ticket for fixed the price of $ 1,000. On the other hand, if on the day of the flight price will drop to $ 500, we still have to pay the agreed forward price of $ 1,000. In this case, we may regret our decision.

Futures contract — is the same forward contract traded on certain stock exchanges and the conditions of this contracts are standardized in a certain way.

Stock exchange on which futures contracts are made, assumes the role of an intermediary between buyer and seller, and thus it means that each part makes a separate contract with the stock exchange. Standardization means that the conditions of futures contracts (ie the quantity and quality of the goods delivered, etc) are the same for all contracts. [3].

A forward contract is often allow to reduce the risk faced by both the buyer and the seller.

One way to insure activities if investor is to hedge by options contracts. When investor hedges his positions using option contracts he must follow the following rules. If he wishes to hedge an asset of the price fall, he should buy a put or sell a call option. If the position is insured from price increase, then sold a put option or purchase a call option.

An option contracts like the forward and futures contracts are related to derivative financial instruments or otherwise to derivative securities.

There are two types of options: call options and put options.

A call gives the holder the right to buy an asset at a certain price within a specific period of time. But this right is not an obligation. Calls are similar to having a long position on a stock. Buyers of calls hope that the stock will increase substantially before the option expires.

A put gives the holder the right but not an obligation to sell an asset at a certain price within a specific period of time. Puts are very similar to having a short position on a stock. Buyers of puts hope that the price of the stock will fall before the option expires. [4]

The premium for the option — this is the amount that the buyer of the option pays to seller for the right to execute or not to execute a contract. The value of the premium is subject of bargaining at the time of the transaction.

A swap is a derivative contract through which two parties exchange financial instruments. These instruments can be almost anything, but most swaps involve cash flows based on a notional principal amount that both parties agree to. Usually, the principal does not change hands. Each cash flow comprises one leg of the swap. One cash flow is generally fixed, while the other is variable, that is, based on a a benchmark interest rate, floating currency exchange rate or index price.

The most common kind of swap is an interest rate swap. Swaps do not trade on exchanges, and retail investors do not generally engage in swaps. Rather, swaps are over-the-counter contracts between businesses or financial institutions.

In an interest rate swap, the parties exchange cash flows based on a notional principal amount (this amount is not actually exchanged) in order to hedge against interest rate risk or to speculate.

Other Swaps

The instruments exchanged in a swap do not have to be interest payments. Countless varieties of exotic swap agreements exist, but relatively common arrangements include commodity swaps, currency swaps, debt swaps and total return swaps.

Commodity swaps

Commodity swaps involve the exchange of a floating commodity price, such as the Brent Crude spot price, for a set price over an agreed-upon period. As this example suggests, commodity swaps most commonly involve crude oil.

Currency swaps

In a currency swap, the parties exchange interest and principal payments on debt denominated in different currencies. Unlike in an interest rate swap, the principal is not a notional amount, but is exchanged along with interest obligations. Currency swaps can take place between countries: China has entered into a swap with Argentina, helping the latter stabilize its foreign reserves, and a number of other countries.

Debt-equity swaps

A debt-equity swap involves the exchange of debt for equity; in the case of a publicly traded company, this would mean bonds for stocks. It is a way for companies to refinance their debt.

Total return swaps

In a total return swap, the total return from an asset is exchanged for a fixed interest rate. This gives the party paying the fixed rate exposure to the underlying asset—a stock or an index for example—without having to expend the capital to hold it.

Despite the risks in the securities market investment of funds in securities are a good source of profit. The essence of hedging is to buy or sell futures or options contracts in conjunction with the sale or purchase of the underlying asset with the same delivery time, and then carrying out the reverse operation with the coming of the day of delivery. Hedging is able to protect hedger against large losses, but at the same time it completely deprives him of the possibility to take advantage of the favorable development of the conjuncture or reduces its profits.


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