Introduction
One of the most important applications in the measurement and control of financial risks refers to the calculation of the value at risk with instruments that involve a maturity term. Debt instruments that are quoted in the money market have a maturity and this attribute makes their risk measurement more complex than in the case of equity or currency securities.
The issue of the intertemporal structure of interest rates, the calculation of forward rates and the procedure of interpolation and decomposition of positions to obtain the value at risk in a portfolio of debt instrument are also discussed.
Abstract
One of the most important applications in the measurement and control of financial risk refers to the calculation of value at risk with instruments that involve a maturity. Debt instruments that are traded in the money market have a maturity and this attribute makes your risk measurement is more complex than in the case of equity securities or currencies.
Also addresses the issue of intertemporal structure of interest rates, the calculated forward rates and interpolation and decomposition procedure for obtaining positions the value at risk in a portfolio of debt instrument.
Development
Interest rates:
Interest rates are the price of money. If a person, company or government requires money to acquire goods or finance its operations, and requests a loan, the interest paid on the money requested will be the cost that will have to be paid for that service. As with any product, the law of supply and demand is followed: the easier it is to get money (greater supply, greater liquidity), the interest rate will be lower. Conversely, if there is not enough money to lend, the rate will be higher.
According to Lara (2000) "the interest rate can be defined as the rate of growth or decrease in the value of an asset in a given period, interest rates are a measure of profit for those who decide to save today and consume in the future".
Capital markets provide an efficient mechanism for transferring capital between economic agents, where the lender receives an interest for the temporary use of his capital.
Interest rate structure:
In the money market, different interest rates or types of interest rates expressed in different bases and different terms must be handled frequently, so that the interest rates are comparable, they must be expressed in the same base and be of the same type. When this happens, it is possible to obtain an intertemporal structure of interest rates, that is, said structure is a consistent way of showing interest rates in different terms or periods.
Future or forward interest rates:
The future interest rates or forwards are those that reflect the expectations of the behavior of the interest rates in the future, the question that must be answered is: can we use the yield curve of interest rates to infer the market expectations regarding of future interest rates?
A forward rate is that interest rate that is between two Spot rates (zero coupon) of different periods, that is, that is implicit between them. In practical terms, an investor should have no preference between the option to invest certain capital at a rate, for example 28 days and then reinvest it at a rate of 63 days, or invest that same capital at a rate of 91 days. The net result for the investor to choose either of those two options should be exactly the same, otherwise there would be arbitrage opportunities.
He reported:
Short-term instruments with specific liquidity, yield, term and risk characteristics are operated in the money market. Therefore, short-term operating modalities have been developed that optimize these characteristics for short-term providers that optimize these characteristics for money providers and demanders.
It is that operation that is always carried out through the conclusion of a contract, in which the "reported" delivers to the "reporter" a quantity of securities-value, in exchange for an agreed price plus a prize or commission, with the commitment that upon expiration of the contract, the reporter returns to the respondent, for the same agreed price, an equal amount of securities of the same species and characteristics, even if they are not physically the same.
This operation is similar to a pledge loan with security in securities - Value, with the difference that in the repo, the "reporter" does not receive the securities in guarantee but in Property, and consequently, during the term of the contract, they can dispose of them freely.
Duration concept:
The concept of duration is very useful in the money market, especially as an indicator of risk, its definition is; duration is the change in the value of a bond or money market instrument when a change in market interest rates is recorded, mathematically it is a derivative of the bond's price with respect to the interest rate.
Convexity concept:
Convexity is a property of debt instruments, when changes in interest rates are very pronounced, as in the case of the Mexican market, the duration of the bond is not sufficient to quantify the potential loss derived from said position.
Value at risk for a debt instrument:
To calculate the value at risk in a debt instrument, it is known that:
dP / dr = -DmP
Where Dm is the modified duration. The percentage change in price is then:
dP / P = -Dmr (dr / r)
Mapping or decomposition of positions:
Mapping is understood as the process by which an instrument can be expressed or decomposed into a combination of at least two instruments that are simpler than the original, that is, describe a portfolio of instruments in their most elementary parts.
conclusion
The main objective of the Money Market is to unite the group of money suppliers and demanders, reconciling the needs of the saving public with the financing requirements for investment projects or working capital by private companies, state-owned companies, the federal government and recently state governments. In general, short-term financial instruments that are sufficiently liquid are traded.
It is the one in which all kinds of bidders and claimants of the various credit operations and short-term investments concur, such as: Discounts on commercial documents, short-term promissory notes, discounts on certificates of negotiable deposits, reports, demand deposits, promissory notes and bank acceptances.
According to Brealey and Stewart (2003) "the money market instruments are characterized by their high level of security regarding the recovery of the principal, as they are highly negotiable and have a low level of risk".
Bibliography
- Alfonso de Lara Haro, Measurement and control of financial risks, 3rd Edition, Limusa.Brealey, Richard A. and Stewart C. Myers, Principles of Corporate Finance, 7th Edition. México, DF: McGraw – Hill, 2003.
