First Published on Finance Training Course.com on 26th March 2011

I recently ran a presentation for a client where I had to justify setting risk limits at a pre-defined threshold for a treasury and investment management function, linking Stop Loss, Value at Risk and Management Action Triggers. The question a very astute board member asked me was a simple one:

How likely is this worst case loss and what would happen when it would actually occur?

To explain my recommendation I had to lean on Nicholas Nassim Taleb and his suggestion of working with most likely loss which in this case (see table above) gave me even odds for a loss of .05%. From a pure expectation point of view it translated into 52,000 US$ alternate day (once in two days, 1:1 odd) for a 100 million US$ portfolio. That is the number the board was likely to see on every alternate day and rather than let the board sit idle and wait for the risk freight train to hit them at some point in time in the future while they were assured by their Worst Case Loss calculations, my and NNT’s suggestion was simple. Track deviation to your most likely loss rather than your unlikely loss. For two simple reasons:

1. You have more data points to understand the distribution
2. The number you quote to the board, the risk function and the treasury group is actually taken a lot more seriously given its likelihood of occurrence.

It also allowed me to link the concept of stop loss with risk limits by helping set a soft stop loss limit just beyond the most likely loss and a hard stop loss limit at the last known threshold of good data which interestingly enough sat between the 51% and 66% percentile threshold.

And if I was really really smart and had the right system and capabilities, I would move these limits around as the underlying portfolio volatility moved up and down in time.

The only exception to this rule was PSR limits (Pre-Settlement Limits) where I simply couldn’t walk away from worst case loss. So my question to you is

1. Have you started thinking about communicating your risk results, targets, exceptions and breaches in Most Likely Loss terms or are you still using Worst Case Loss?
2. Does your Board appreciate and understand and react better to Most Likely Loss or Worst Case Loss?
3. Have you connected your stop loss triggers and thresholds to trailing market volatility?

If you would like to learn more about the topic of setting limits and using most likely loss rather than worst case loss please see our setting limits online video course at Finance Training Videos

This post was first published at Learning Corporate Finance as part of the launch campaign for Finance Training Videos.

Understanding N(d1)

It is embarrassing to confess but it is a question that stumped me the first time a student posed it.

What is N(d1) and how is it different from N(d2)?

The difference is as subtle and fundamental to derivative pricing as is fission and fusion in nuclear physics. In today’s volatile markets a subtle oversight is all it takes to land you right in the middle of a core meltdown.

Over the years I tried different explanations, carefully measuring each trial’s confusion potency. Most explanations around Black Scholes turned bright, smart, hard working exec MBA students into glassy eyed zombies within a few minutes. At times I also wondered what if that sharp trader at the Goldman interview in London had posed this stumper. Would my answer and my life turned out differently?

So when we were done with our very first video based risk training offering focusing on value at risk and capital, I knew that the next course had to be on explaining N(d1). Fortunately for me a ready audience of 30 students awaited me at the SP Jain campus to try out my latest thought experiment. Together we broke the Black Scholes equation down and put it under the microscope using the Monte Carlo simulator as our lens.

I can safely say that led to some very interesting conversations. We finally understood what conditional probabilities mean after a little bit of pain. But there is only one way you can find out if there are thirty zombies waiting for you in LC-1 at Academic city. No peeking; Try out the new Understanding N(d1) course now.

When you are running a 10,000 trial Monte Carlo simulator it is difficult to stop with just N(d1). An expanded version of the course walks you through the process of building the entire Monte Carlo simulation in Excel and then helps you extend the same model to pricing Asian, Knock In and Knock out options.

If all this talk about simulation and obnoxious variables turns your stomach you can also try our much lighter, philosophical peace offering, the Quant Crash Course for non-Quants.

Try any of the three courses before 31^st March 2011 and take advantage of our US$ 99 launch prices valid only for the launch month of March (our Ides of March discount). Effective 1^st of April prices revert back to their normal US$ 199 price tag.

Later modules scheduled for release post March cover tools to reduce variance, increase price convergence as well as add additional products in the FX arena including digitals, binaries, participating forwards and structured packages.

With the introduction of video based training traffic at the site has really surged in the last two weeks. If for some reason you get timeout errors especially with video sessions please drop me a note and bear with us while we work at scaling up our streaming server capacity.

This week we expect to break 3,000 weekly visitors and 8,000 weekly page views. As of March, the Finance Training Course platform has already crossed 60,000 visitors and 135,000 page views, with traffic doubling every four months. We wouldn’t be here without the role all of you have played over the last four years in getting Finance Training Courses and Alchemy to where they stand today.

Thank you.

Yours

Jawwad

(Ps. I will look forward to that note J)

In the summer of 1987, Lotus Symphony was the category killer in the integrated spreadsheet market. It was also my first introduction to the animals called spreadsheets and financial models. While other 16 year olds were doing things that 16 year olds are supposed to do in the summer, yours truly was digging through Symphony help to figure how to link a financial model together. A side lane off Zamzama, sitting on a sunlit desk on the mezzanine floor of an office which is now just a fond memory, one late afternoon I turned a static worksheet into a dynamic thing of beauty.

It would be an understatement to say that the direction my life was supposed to take changed that day. Many a spreadsheets and a few years later I possibly became the fastest teenaged draw with a spreadsheet you could find East of the Persian Gulf and the Arabian Sea (a dubious claim at best). Fate dealt another kind shove and I found myself in an undergraduate program in computer science and for a while my love affair with spreadsheets was put on a hold. Tempted by semaphores and operating systems, compilers and the C language, the Borland IDE and code, I sort of forgot myself for a few years.

Till one fine evening when I opened the second edition of John C. Hull. I wish I could say it was love at first sight but it was more of a love and hate relationship. I loved the fact that I was finally studying Derivative Pricing and Risk Management; I hated the fact that I couldn’t decipher the language or the material. Oh it was plain English but such a torturous variant that it brought tears to my eyes every time I wandered too far off from the numerical examples. Alas Destiny played me for a victim for 5 long and painful year where I read Hull cover to cover 6 times a year, took the Fellowship actuarial exam on the text, failed it and then tried again the next year and the following year and the following year.

Flash forward to 1999, the year I left my internship at Goldman to start at Columbia Business School in New York. Three people helped break the curse of Hull (forgive the pun) and re-ignited the love affair with the sheet. Maria Vassalou, the Continuous Time Finance professor at the business school who allowed me to sit through her PhD elective that dissected the Black Scholes equation; Mark Broadie, the Security pricing Guru in Uris Hall who for the first time showed me the things one could do with spread sheet if one put his mind to it and Howard Corb, the Derivative Trader from Morgan Stanely who amply demonstrated every Tuesday evening how little us lesser mortals knew about the derivative trading desk and the derivative business and why Morgan and every other bank on the street was justified in not giving us the time of the day come recruiting season.

Twelve years later, I would still be embarrassed if I met Maria, Mark or Howard on the street (or for that matter any of my Columbia class mates who work on the street). Hull has finally stopped tormenting me. I am no longer the fastest draw on a spreadsheet, East of the Persian Gulf. But after confusing and tormenting more than 1,500 students in Bangkok, Singapore, Kula Lumpur, Dubai, Riyadh, Abu Dhabi, Karachi, Lahore and Islamabad, I would like to believe that I now know a little bit more about pricing derivative securities on a spreadsheet. Certainly more compared to the 16 year old who stared dumbfounded at his screen when his summer long effort finally came together that afternoon in July 1987.

Throughout this 24 year journey I wished and searched for something online that would ease the pain of grasping the alien concepts of stochastic calculus, computational finance and risk management. About a year ago with Finance Training Courses I took the first step in creating a resource that another me in an alternate universe could use. By the end of this week, we will hopefully have the second iteration of that resource out. Armed and dangerous with a video and certainly not afraid to use it!

If you have ever been in love with a spreadsheet or a pricing model; or hated your 18^th run of Hull without understanding a word of it; or needed a spiffy answer to a question posed by our beloved Howard Corb, just so that you can make the right impression, the Online Quant Crash Course (for the non Quant?) is for you. Rather than limiting ourselves to PDF and excel files we decided to play with Finance Training Videos, the new home for online video based quantitative training.

Take a look at the Quant Crash Course samples as well as the Quant Training Crash Course pre-course announcement and keep an eye out for the “We are now live” announcement. The announcement should be up latest by this Friday (if not sooner) and we are almost done with the logistics behind the course. And if you like what you see please feel free to drop me a line telling me how I could do a better job. For there is nothing more, that we underappreciated (and occasionally underpaid) authors and trainers like more than a note (abusive or appreciative) from someone we have never met before from a place we have never been to in our lives.

It took two students, over a hundred training engagements in 6 markets and a life working with risk and finance to change my mind.

2007 was a good year in many ways. It was also the year when Abbas Qureshi at SP Jain, Dubai and Adnan Iqbal at Deloitte Consulting, DC asked me the same thing. “Can you please start putting up your training materials online? There are tons of individual out there who would pay good money to let you teach them online.” I wasn’t sure if I was the video guy, if we had the bandwidth or if I really wanted to do this. Two previous attempts to record workshops had worked but with disastrous results.

While Finance Training Courses was a first step in this direction, Adnan and Abbas both felt that something along the lines of Khan Academy would be a lot more useful. There is only so much you can read and a good instructor with a good deck can simply beat plain text hands down. While I wasn’t sure if such a model would ever take off financially, Salman Khan quickly became the inspiration and the guide on the path for putting videos online.

About two months ago we started thinking about putting our slide decks online for the most popular courses on the Finance Training Course portal. The first milestone was investigating WordPress capabilities (you can do about 50 meg per video per post using wordpress), a search on tablets and the tools of choice used by Salman Khan (Wacom Fun Touch Bamboo versus the Genius much cheaper and larger pen only tablet), the software required (Camtasia by Techsmith) for the work Salman has done and we were there.

The first video on liquidity risk management took over a week to plan. While the content had been around for a while, it took me a while to convince myself that I was finally ready to put videos online. Something we had always talked about but never done. The Quant Crash Course took even longer. While the first course on liquidity was just the proof of concept, the second was supposed to be the real thing. This evening we put the first episode of the four part quant crash course online. Hopefully before I head out to Abu Dhabi on Tuesday the whole series will be up and running and available for sale.

Ever since we started preparing ICAAP (Internal Capital Adequacy Assessment Process) submission reports the two areas where clients had the most questions dealt with estimation of internal capital for strategic and liquidity risk. One client went as far as saying that I don’t want to discuss Pillar I at all. I understand Pillar I. It is Pillar II reporting and risk that is giving me reporting nightmares. Specifically ICAAP Liquidity Risk and Strategic Risk Capital.

Here are two posts done earlier on Finance Training Courses for our clients related to these two missing links:

ICAAP: Estimating Liquidity Risk Capital for ICAAP

ICAAP: Estimating Strategic Risk Capital for ICAAP

Jawwad Farid is a Columbia Business School Alumni, a Fellow Society of Actuaries and the Founder CEO of Alchemy Technologies. Jawwad has been teaching and working with the banking industry on ICAAP frameworks and submissions from early 2007 when the Basel II framework was rolled out in the region. For more detailed material on ICAAP prepared by the same team, please see  Sample ICAAP report templates, ICAAP Excel worksheets and a primer on ICAAP as well as our ICAAP Training workshop series scheduled for late March 2011 in Langkawi, Malaysia. 

Two ICAAP training workshops, three days, one magical location. Our second set of workshops covering exotic financial topics in breathtaking tropical locations.

A focus on ICAAP – Pillar II risks primarily ALM and Liquidity Risk Capital using Interest Rate Simulations. The two day main event is preceded by a single day foundation workshop on Internal Capital Adequacy with a focus on treasury, market and counterparty risk management. For details, please see the main training workshop pages below.

ICAAP Training Workshop – Treasury, Market and Counterparty Risk Foundation Workshop – 29^th March, 2011

ICAAP Models Training Workshop: ALM, Liquidity and Interest Rate Simulation Workshop – 30^th, 31^st March, 2011

Discount available for early registration and multiple nominations from the same institution. Book online using Google Checkout or directly with LSW in Malaysia. Local discounted rates available for a limited time for participants from Malaysia, Singapore, Thailand and existing LSW and Alchemy customers. Please see ICAAP training workshop brochures for more details.

ALM and Liquidity Management Training Workshop

This advanced level ALM and Liquidity Training workshop serves as a refresher to liquidity management, with an emphasis on traditional models including gap analysis and earnings at risk, stress testing, scenario planning, policy making and simulations. Our first joint venture finance training workshop in Kula Lumpur with our Malaysian Partners LSW International scheduled for 27^th and 28^th January, 2011. 30 minutes from Kula Lumpur at the Holiday Villa Resort in Subang, Malaysia.

ALM Training Workshop Learning objectives

At the end of this workshop the participants will be able to:

1. Work with the primary tools required to measure and manage ALM risk profile of a financial institution
2. Measure liquidity and quantify the effectiveness of traditional measurement tools.
3. Use scenario based methods, stress testing and simulations to highlight your ALM and liquidity risk profile.
4. Develop assumptions for testing Maturity mismatch and liquidity risk for Internal Capital Adequacy Assessment.
5. Assess and evaluate existing liquidity policies and contingency plans.

About ALM and Liquidity Management Workshop location and facilities

The Holiday Villa Subang is a premier business resort offers an ideal getaway for business and leisure. The Hotel is set on 6.8 acres of beautifully landscaped land overlooking a pristine lake while incorporating the luxuries of modern facilities. Its features 383 spacious guestrooms equipped with modern amenities, 10 food and beverage outlets that offer guests a choice of global cuisine, 18 convention and meeting facilities including three ballrooms and finally, a comprehensive range of sports and recreational facilities including an Olympic-sized swimming pool.

ALM Training workshop level: Intermediate and advance users. This advance level workshop is aimed at individuals responsible for asset liability management and risk management within banks, insurance companies and mutual funds. Familiarity with basic liquidity concepts, local markets, portfolio management and the Basel II framework. All participants are requested to arrange Laptops with a functional version of Microsoft Excel.

ALM and Liquidity Training Workshop Course OutlineLiquidity and ALM Models: Overview and introduction. Key terms and concepts. Duration, Convexity, Maturity mismatch, measuring mismatch, ALM models, assumptions and drivers. Basic tools – Price and Maturity GAP, MVE and NPV Analysis, Net Interest Income, Earnings at Risk, Cost to Close and Liquidity.

BancOne Case Study:

ALM and Liquidity Policies and Simulation: Structure, Policies, Tools, Stress tests, ICAAP and Scenario analysis for Liquidity. Building the contingency funding plan.

Facilitator profile

Jawwad Farid is the founder and CEO of Alchemy Technologies, an enterprise risk practice that builds and deploys risk, treasury, ALM, ICAAP, market and credit risk platforms. He is a Fellow Society of Actuaries (Chicago), a MBA from Columbia Business School (New York City) and a computer science graduate. During the last 18 years, he has worked as a consultant in North America, Pakistan and the United Kingdom with a number of blue chip clients including Hartford Life, Aegon, American General, Goldman Sachs, ING, Manu Life, Safeco, Merrill Lynch, Met Life, Sun America, Nationwide, Phoenix Life, Sumitomo Mitsui Bank, Sun Life of Canada, Pacific Life, AllState, Fidelity Investments, Transamerica, Skandia, GE Financial Assurance, Lincoln National, Ohio National, AXA Equitable and Washington Mutual Bank.

Jawwad’s core areas of expertise include Asset/Risk Management, Investments, Product Development and the Financial Services Back Office. Jawwad blends a rare combination of risk management, information systems, international standards, business and product development skill set side by side with his actuarial expertise. His regional client list includes Asian Development Bank, First Gulf Bank, Riyad Bank, Dubai Islamic Bank, Noor Islamic Bank, Dubai Bonds, Deutsche Bank, State Bank of Pakistan, National Bank of Pakistan, Muslim Commercial Bank, Crescent Commercial, MyBank, Dawood Islamic Bank, KASB Bank, United Bank Limited, Pak-Kuwait Investment, Saudi Pak Commercial Bank, ABN AMRO, InvestBank, Invest Capital Markets, State Life Insurance, Dawood Family Takaful, Asia Health Care, Adamjee Insurance, Shell Pakistan, International General Insurance and Securities and Exchange Commission of Pakistan. Jawwad is also a regular contributor to the Learning Corporate Finance portal as well as on the SP Jain platform where he teaches courses on Entrepreneurship, Risk Management and Derivative pricing to executive MBA students in Dubai and Singapore.

Jawwad’s expertise includes:

• Appointed actuary.
• ALM, Liquidity Management and ICAAP.
• Risk based capital, investment and portfolio optimization strategies.
• Fixed Income, Foreign Exchange and Commodities (Oil) research.
• Basel II market, credit and operational risk management framework.
• Probability of Default modeling and Days Past Due analysis.
• Centralized or distributed Middle & Back office design, review, integration, assessment and deployment for banks, brokerage, mutual funds, and insurance companies.
• Derivative pricing, application and usage.
• Valuation of contingent products, benefits and solutions in investments, portfolio management, life insurance, general insurance, finance and risk.
• Development and conduction of individual and institutional skill development & capacity building programs.

For more details, pricing, registration and multi nomination discounts please contact

M. Shakila shakila@lswinternational.com or Leonard (leonard@lswinternational.com)

LSW International Sdn. Bhd. (765510-K)

623, Block B, Mentari Business Park

Jalan PJS 8/5, Bandar Sunway

46150 Petaling Jaya, Selangor Darul Ehsan

MALAYSIA.

Tel         :+603 5637 2379

Fax        :+603 5637 0366

Weighted Average Cost of Capital (WACC) is an important input in the process used for determining the value of a firm. In our Corporate Finance First Course we visit this concept as well as the concept of Beta which is an essential ingredient in the Cost of Equity calculation part of the WACC equation. In particular the following two sessions discuss these topics in detail:

1. Finance Training Course: Corporate Finance: Opportunity Cost and Cost of Capital
2. Finance Training Course: Corporate Finance: Beta, Calculating WACC or Weighted Average Cost of Capital

These concepts as part of a business valuation exercise are more clearly explained through the following two case studies:

1. Finance Training Course: Advanced Micro Devisces (AMD) Corporate Finance case study
2. Finance Training Course: Electronic Arts (EA) Corporate Finance case study

Finally we look at how Beta may be re-levered to address situations where a firm’s capital structure has undergone change or where data for determining beta for firms will similar business risk is more readily available than for the firm being valued.

Corporate Finance Training Course: WACC: Calculating weighted average cost of capital: Relevering Beta

Between the two introductory concepts, the two comprehensive cases and the Relevering Beta post above you now have everything you ever needed to learn about Beta within the context of corporate finance and investment banking valuations.

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2. Corporate Finance First Course | Finance Training Courses  – 256 Views
   
3. ICAAP Internal Capital Adequacy Assessment Sample ICAAP report format and table of content | Corporate Finance Training Courses – 248 Views
   
4. The Derivatives Crash Course for Dummies | Finance Training Courses  – 192 Views
   
5. Calculating Forward Prices, Forward Rates and Forward Rate Agreements (FRA) Calculation reference | Corporate Finance Training Courses – 179 Views
   

The top posts on Finance Training Courses this month in December 2010 directly from Google Analytics. The finance training course store is getting good traction, followed by the first course in corporate finance for finance neophytes, followed by our most popular download on ICAAP. In terms of Click Through (CTR) traffic, the calculating forward rates reference has the highest CTR of over 20%.

Duration & Convexity Calculation Example

While mathematically speaking duration and convexity are simple topics, somehow Risk heads and Quants in general have a difficult time explaining both to retail banking, senior executive teams and board members. I thought a working example of duration and convexity illustrating the differences between Macaulay, Modified and Effective Duration side by side with an illustration of Convexity would help the cause. We may still lose the battle for hearts and minds when it comes to these two topics but we would know that we had tried.

In the posts that follow we will look at the specific mechanics of the Duration (i.e. Macaulay Duration, Modified Duration and Effective Duration) and Convexity calculations.

Duration, Convexity calculation example: Working with Macaulay & Modified Duration
Duration, Convexity Calculation Example: Working with Effective Duration
Duration, Convexity Calculation Example: Working with Convexity and Sensitivity
Interest Rate Risk: Convexity
Duration, Convexity and Asset Liability Management – Calculation reference

For a more advanced understanding of Duration & Convexity and its application in a banking setting please see the Asset Liability Management – The ALM Crash course and survival guide.

If you would like to buy this example as an excel file, please see the Computational Finance section at our online finance course store. The online finance course store  includes easy-to-read-and-work-with downloadable pdf files, excel templates and ready-to-work with models that are shared to illustrate usage and speed up learning for advanced financial modeling, forecasting and simulation topics including interest rate forecasting and simulation, value at risk analysis, credit analysis and processes, Internal Capital Adequacy Assessment Process (ICAAP), asset liability management and other related middle office and risk and computational finance topics.