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Risks Management And Assessing The Risk Management Strategies

Chapter 1: Background

1.1 Introduction to the Organization

J.P Morgan Chase headquartered in New York is the leader in the financial services providing solutions to clients in more than hundred countries possessing one of the most comprehensive global platforms. J.P Morgan is in the business for more than two hundred years. The core principle of the organization has been to put the client’s interest first. J.P Morgan is the leader in the management of assets, investment banking, private banking, treasury and securities and commercial banking. The objectives of the American based organization are to help clients succeed contribute to orderly and well-functioning markets and support global economic growth. In the investment banking sector the organization provides clients with excellent strategic advice, lends money, raises capital, assists in managing the risks makes markets and extends liquidity. One of the vital activities of the organization is to extend credit to organizations that help them grow. The organization has developed various risk handling models to help its clients operate safely in the risky business markets (JPMorgan, 2010).

1.2Need for the Research

The present research is based on the risk management and the strategies involved in the process. The research also extends to the practical risk management strategies being used by the organizations in the investment banking sector. The research is worth the effort because it is delivers knowledge not only about the concepts involved in the risk management but also regarding its applications in the real time scenario.

1.3 Area of Research

Risk is universal and resides at the heart of all economic activities of individuals, businesses and governments. Risk management is the process of identifying the risks, evaluating it and then decisions are made and implemented for the most effective means of managing the risks. From the macroeconomic standpoint the techniques of risk management can decrease the number of commercial and industrial enterprises that would otherwise become insolvent. The most striking benefit of effective risk management results from loss of control. Effective loss control techniques can minimize the frequency and intensity of disasters. Risk management helps in developing the new businesses and assists the existing businesses to be capable of competing in domestic and foreign markets (Skipper and Kwon, 2009). Risk management strategy involves three interrelated components they are risk identification, risk evaluation and risk mitigation. Each of these components has different assessor and purpose. Identification of potential risk is the initial step in risk assessment. If risk identification is not done properly then risk analysis will be defective in potential implications. Risk identification can take various forms and it all depends on the nature of task and also on the impact and frequency of the risk affecting that task. The next step in the risk analysis is the risk evaluation in which the consequences associated with each risk will be considered. It is important to next elaborate control measures that are presently available to mitigate risks. Another element of risk evaluation is the task of comparing the levels of risk to organizational or business tolerances. Occurrence of risk is not only confined to controllable events but is also dependent on the events for which there is no control. Once risks are identified and the consequences are elaborated a risk mitigation strategy should be deployed. This strategy should emphasize on risks and exposures that the organization considers as intolerable. Risk mitigation may involve altering the existing control measures, implementing new ones or avoiding activities that could cause risks. In implementing a risk mitigation strategy it should address two things one is to reduce the frequency of the risk and the second is to minimize the impact of risk occurrence (Cendrowski and Mair, 2009).

1.4 Investment Banking

Investment banking is by far the most globalized segment of the financial service industries. Commercial banks in the present day scenario are starting to offer investment-banking and merchant banking services to larger corporations therefore entering in direct competition with prestigious investment houses. Its services include

Identifying possible merger targets

Financing acquisitions of other companies

Dealing in customers’ securities

Providing strategic advices

Providing dodging services against market risks.

To deal with the rising costs and squeezing margins created by competition investment banks require partners with large amounts of available capital. Investments banks are taking risks for the want of higher returns. This policy has taken two distinct forms first is to increase the riskiness of their existing businesses. This can occur for instance when an equity dealer underwrites the whole lot therefore taking full risk of adverse market movements. The second one is called as proprietary trading which means that investment banks fund operate similar to in-house hedge funds and hedge funding is relinquished as one of the riskiest financial businesses. Proprietary trading also increases the need for capital to cope with unavoidable loses in trading and favors consolidation between investment and commercial banks that are much better capitalized (Penza and Bansal. 2001)

1.5 Risks in Investment Banking

Investment banks are exposed to risks like that of the financial intermediaries but in varying degrees. The main risk categories for the investment banking are market, credit, operating and liquidity risks which are as follows

Market Risk: Market risk is the potential change in the value of financial instrument caused by fluctuations in interest and currency exchange rates, equity and commodity prices and credit spreads. Risk management in this category is responsible for assessing, monitoring and control of market risk on trading positions that include the establishment of trading limits throughout the firm. A prudent investment banker will view the main risk of the product as not being in the product itself but in the manner the product is managed. Discipline or lapses in supervision can cause losses irrespective of the products involved or mathematical models that are used for dealing with the risks.

Credit Risk: This kind of risk represents the loss the firm would incur in case counterparty or the issuer failed to perform in contractual obligations. The investment bank should have stand by policies and procedures with the intention of safeguarding against these losses. The policies and procedures may include

Reviewing and establishing limits for credit exposures

Further limiting counterparty credit exposures through various techniques that include collateral and obtaining the right to terminate transactions or collect collateral in the event of credit default or downgrade.

Frequently evaluating the creditworthiness of counterparties and issuers.

Operating Risk: This type of risk emphasizes on the ability of the firm to accumulate, process, protect and communicate information necessary to perform everyday activities either in a domestic or global environment. It includes execution of lawful, fiduciary and agency responsibilities. Eminently organized investment bank manages operating risk in various ways that includes back-up facilities, using technologies, employing experienced personnel and maintaining a comprehensive system of internal controls. As accidents do happen the investment bank continuously reviews its frame work of internal controls considering the circumstances that are changing and initiates corrective actions to address control deficiencies and opportunities for improvement. Fiduciaries and agents certainly have obligations to act behalf on others. These types of risks are inherent in brokerage and investment management activities. The prudent investment banks should be having in place policies to ensure that obligations to clients are met and the firm is compliance with regulatory and legal requirements that are applicable.

Liquidity Risk: This type of risk occurs in the course of the firm’s general funding activities and in the management of the balance sheet. It includes both the risk of being unable to create funds with appropriate maturity and interest rate characteristics and also there is a risk of being unable to liquidate an asset in a timely manner at affordable prices. The firm’s liquidity management strategy should include the maintenance of alternative funding sources and the diversification of those sources for example credit lines with other financial institutions. The object is to assure that debt obligations within may be one year can be funded without issuing new debt or liquidating assets.

Other Risks: The investment bank faces political, tax, regulatory and other risks. These risks move around the impact that changes in local laws, regulatory requirements or tax statutes would have on the viability, profitability or cost-effectiveness of existing or future transactions.

1.6 Limitations of the Research

Risks in the investment banking are of various types and the type of risk associated with one bank would certainly differ from other bank. The risks that commonly happen in most of the banks are only described in the research. The type and the occurrence of risk would also differ from one geographic location to other. It is also not possible to describe all the risks that are witnessed by global investment banks. JPMorgan provides the risk management strategies which may be effective for certain risks only but not for all the risks that occur and that are being faced.

1.7 Previous Work Done

During the graduation I have studied about the risks and also about the risk management strategies. I have done works related to the risk management in organizations and also risk management performed by IT organizations while implementing their projects. I was able to know about the risk that existed within an organization and also about the risks that would occur from outside the organizations. While working with risk management strategies in IT organizations I was able to know about the risks involved in the planning, implementation and maintenance phases of the project. Some of the risks associated with the maintenance phase of the project were increase in maintenance costs, changes in technology, insufficient end user support and others.

1.8 Risk Metrics Model

Risk metrics strongly assumes that the returns are conditionally normally distributed. As the standard deviation of returns is higher than the mean so the mean is neglected in the model. The typical yearly mean return in equity markets is 5% while the typical standard deviation is 15%. In the risk metrics model the estimate is used as a one-day ahead volatility forecast. If this estimate is used to calculate multi-period forecast using the simple square-root-of-time then quality forecast is bound to decline with number of periods. The model sets the confidence level at 95%. The prescription to obtain this 5% quantile is to simply multiply the volatility estimate by 1.65 considering the returns to be conditionally normally distributed. It is usually found that despite the presence of fat tails for many distributions the 5% quantile is roughly -1.65 times the standard deviation. Higher the significance levels the effect of fat tails becomes stronger and therefore VaR will be underestimated if normality is assumed. Therefore it can be concluded that the satisfactory performance of Risk Metric in estimating Var is mainly the artifact of the choice of the significance level of 95%. Existing capital adequacy regulations require 99% confidence at this stage Risk Metrics systematically reduces the risk (Pafka and Kondor, 2001)

1.8.1 The Kapital System

JP Morgan has developed Kapital the considered as the world’s most financial risk management and pricing system that supports Interest Rates Hybrids and Credit Hybrid trades. Two main differentiators are used by JP Morgan’s Kapital System that kept them above in the competition. They are time-to-market and scalability of the offering. Identifying new market opportunities are essential for investment banks. Profitability, success and giving customers best on the return investment however comes for being able to execute those new market opportunities before the competition. The seamless integration between the financial application framework and the technical infrastructure provided by the Kapital system enables both business and IT staff to model and develop new ideas that can be directly promoted into product sets. Able to develop new complex deals faster is not the only factor required enabling an organization to have the edge. The goals of the Kapital System are as follows

To be the prime record for entire credit and interest rate hybrid derivative trades at JP Morgan

To calculate the exact value of all its deals on daily basis

To inform the authorities regarding the loss or profit the organization is going to make based on the changes in the market conditions

To assist mid office in handling large number of hybrid derivative deals

To support quick time-to-market for new product development

From an IT perspective Kapital is

Framework for constructing new financial applications

Complete development environment including source code management and debugging options

Transparent mechanism that is persistent and enables the storage of any type of financial object

It is also distribution infrastructure that facilitates the distribution of any type of financial task (JP Morgan, 2006)

Chapter 2: Industry Background

Investment banking is a banking activity that is not categorized as commercial banking. Within banking whatever is not commercial can be defined as investment banking. Differently from commercial banking investment banking includes heterogeneous set of activities that can be distinguished into three main areas they are Core or traditional, trading and brokerage and asset management. The core or the traditional banking can be further fragmented into two categories. First is the underwriting services that assist firms increasing their capital on financial firms and second is the advisory services that assist firms in transactions like mergers, acquisitions, debt restructuring and others. The trading and brokerage comprises purchasing and selling securities by using the bank’s money or on behalf of the clients. The asset management is a heterogeneous area as it deals with managing investors’ money. It can be split into two main categories namely traditional asset management and alternative asset management. The alternative asset management includes real estate funds, hedge funds, private equity funds and any similar activity in alternative asset classes (Iannotta, 2010)

Chapter 3: Aim and Objectives:

3.1 Aim

The aim of the research is to acquire knowledge on the risk management and to know about the risk management strategies being used in investment banking.


To study about the risks and occurrences of risks in the investment banking organizations like J.P. Morgan Chase

To gain information on the risk management strategy in J.P. Morgan Chase and the techniques being used in the process

To study the impact of models developed by J.P Morgan Chase for handling the risks effectively.

3.2 Research Question

The research revolves around the need for risk management strategies in investment banking. This is because the investment banking sector is prone to risks similar to that of the stock markets. The differences are the impact and also the timing of the risks varies. The next question would be to evaluate the effectiveness of risk handling models developed by JP Morgan which is one of the world’s leading investment banks.

3.2.1 Research Hypotheses

The research hypotheses are as follows

RiskMetrics Model

Kapital System

Chapter 4: Research Methodology

4.1Research Philosophy

This chapter describes the mode of research performed to gather the information related to the research topic. This chapter also details about the rationale of the research and then describes how the research tools namely interviews and focus groups are used. Research methodology depicts a clear structure and assists in collecting the data for the following research.

It is known fact that researches are classified into two categories namely qualitative and quantitative. Qualitative research deals with data that is theoretical and descriptive form. Most of the researches performed are qualitative researches. The data gathered by the qualitative research is easy to understand and also rich in information and above all delivers quickly much faster than quantitative research. The research methods like the surveys, questionnaire, case studies, focus groups, interviews and others are categorized in the qualitative research. The type of research method to be used entirely depends on the research and also on the field of study. The next type of research is the quantitative research in which the data gathered is in the form of numeric. This method uses various statistical and mathematical models in its modus operandi. This research methodology takes time to deliver results as it takes time to evaluate the numerical data and frame corresponding theory from it. The research method suitable for this study is the qualitative research method.

The data collected from any research is classified into two forms primary and secondary data. Primary data is the data that is collected by the researcher by visiting the field of study and performing interviews and other information gathering activities. The primary data is rich in information and is also reliable to a great extent. But it takes significant levels of money spending and time allocation. Researchers with genuine experience can only have the ability to collect the primary data. The issue with the primary data is it takes time to develop primary data by the researcher as it involves various activities to present the research information in an understandable form. The next type of data is the secondary data. This type of data is easy to be collected as there are many sources that provide secondary data. Some of them are books, libraries, journals, newspapers, internets, societies and others. The secondary data is not as reliable like the primary data and can also provide information that is not significant to the required level. The data that is used in the research is the secondary data.

4.2 Data Collection Tools

The chosen qualitative research methods are interviews and focus group methods. Interview method is used to interview the mangers working in the investment banking sector. The interview is arguably the most widely employed method in qualitative research. The main reason for using the interviews is the flexibility. Interviews are best suitable for gathering information when there is only a single chance. Interviews are used to gather information from famous personalities like leaders, presidents, politicians and other officials. Therefore interviews are best suited for gathering information from managers. Interviews are mainly classified into three types they are unstructured, semistructured and structured. In the unstructured interviews the interview questions are not framed prior to the research and are mostly based on the situations. The next type of research is the semistructured interviews in this only the structure or the topics to be covered in the interview are present. The present research uses semistructured interview. The semi structured interview is the most commonly used interview method among all the interview methods. The final type of interview is structured interview which is similar to the questionnaire method but the only difference is the presence of the interviewer (Bryman and Bell. 2007). Structured interviewing provides same almost identical interview questions for all the respondents. Structured interviewing involves use of an interview schedule, an explicit set of instructions to interviewers who question orally (Bernard, 2000). Structured interviews are used in this study to some extent. An interview schedule is a formal list employed in interviews to assist in the collection of data systematically using the questions. The content, wording, and the interview sequence are prefixed in advance to act as a guide for collecting information pertinent to the research. Some researchers opine the objective questionnaires as an interview schedule. In the structured interviews the flow, content or the wording are rarely changed by the interviewer. This is because in some instances the interview schedule is set by higher authorities of the interviewer. Structured interviews are the mode considered for analytic research and it is applicable equally for gathering data by face-to-face or telephonic interviews (Sinha and Ghosal, 2006). In this research interviews will be performed on managers who are from various investment banks. The issues and the risks related to the investment banking sector will be discussed. The areas in which the investment banking is highly prone to risks will be made known from the managers’ point of view.

Focus Group: Focus group research method is one of the most flexible research methodologies. In the focus group method a sample of the population or the people related to the field of study are considered. The apt number for focus group would be from six to twelve. Involving lesser or more than the specified number would cause deviations in the results. In this research the sample population is first tested with knowledge on investment banking industry people who fit the requirement are only considered. Focus group method is one of the flexible methods because the respondents have a chance to clarify the doubts with respect to the interview question. This facility is absent in the questionnaire, survey and other methods. Focus group is considered to be a sample of the existing population so the results of the research would greatly resemble the actual scenario (Flick, 2009). Focus group interviews developed in the behavioral science research as a distinct member of the qualitative research family that also consists individual depth interviewing, ethnographic participant observation and projective methods and others. Focus groups have become so effective that it has become of the options for large research projects. Focus groups will materialize differently in different fields. Qualitative sociologists have utilized focus groups to analyze the extremely multiple group behaviors that include social patterns and others. Focus groups are friendlier and they can be used and analyzed quickly when compared with other statistical methods. They provide in roads to obtain rich information (Stewart et al, 2007).

The sectors intended to encompass using the above research are the existing market risks, credit risks, operating risk and liquidity risks that are being faced most of the investment banks. The research is also performed to know about the models developed by JP Morgan. To a large extent the research is performed in and around the investment banking sector. It should be noted that investment banking sector is different from other banking sectors therefore the types of issues and the risks that are present in the investment banking sector certainly differs from the common banking activities. The research is also intended to gather information about the impact of risks in the investment banking sector.

The research is reliable to a significant level because the research is revolving around the real time risks that occur in the investment banking sector. The research also involves the functionality of the leading investment banks the JP Morgan. Gathering the knowledge from the JP Morgan’s risk management strategies the reliability of the research is further enhanced. The risk management models used by JP Morgan are presented clearly so that it would help in knowing about the risk management strategy being used by JP Morgan. Further the research also involves the opinions and views of the managers from investment banks which would throw light on the hidden issues that are present in the investment banking. In the next step the research also involves the focus group interviews that would help in knowing the types of risks being faced not only by the organizations but also the investors who invest in the investment banking.

Chapter 5: Time Schedule

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