Use Panels to holdRisk Market statements ► Subtitle (EY Interstate 16 point) ► Medhansh Jain XX Month 200X (EY Interstate bold Shrikar Bang 16 point) Index ► Executive Summary ► Industry Overview ► Baggings Income Statement ► VaR Historical Data Model ► VaR Simulation Model ► Limitations of Risk Management ► Geopolitical Risk ► Integrating Risk models in ERM Strategy Executive Summary Overview Objective Recommendations • • • Baggins Ltd. is a oil manufacturing company headquartered in Mumbai with two plants, each being located in Mumbai and Kochi respectively. Last year they suffered export losses of INR 72 crores due to market volatility and inappropriate hedging strategies. To present appropriate financial risk models and propose hedging strategies for Baggins Ltd. to cover their losses. • • We ran two different risk assessing models to find out about the risk exposure to Baggins Ltd. According to the VaR historical model we propose hedging against brent oil futures contracts over a short period of time. The VaR simulation model shows us that for guaranteed profits we need to hedge against brent oil futures over large periods of time. Industry Overview • • • • • Cumulative crude oil production during FY 21-22 was 29.7 MMT. India‘s refining capacity stands at ~251 MMTPA as of October 2022, Crude oil processing increased by 9% from 221.77 MMT in 2020-21 to 241.7 MMT in 2021-22. India Imported 212.4 MMT crude oil, worth $ 120.7 bn. The import dependency of crude oil was 85.7%. • Export of petroleum products increased by more than 100% from $21.4 Bn in the FY 2020-21 to $ 44.4 Bn in the FY 2021-22. India Crude oil Production Company Income Statement Gross Profit Margin 34.3% Net Profit Margin 20.4% Tax Rate 30% • • • • • The data above shows the VAR for Brent Crude Oil prices for the past 1 year. Using the VAR model gives us precise values for risk losses based on historical corporate data. According to the model, there is a scope of a loss of INR 487 at a 95% confidence level in Brent Crude Futures. To Protect Baggins Ltd. from further losses, we can plan on Hedging Brent Oil futures contracts over a certain period. According to historical data, brent crude oil futures prices dropped from USD 111 to USD 75 in 1 year. • • • • The data on the right shows the projections of the prices of brent crude oil futures (in USD) for the next one month. Follow the historical data model, and taking a look at the projections, we can hedge futures for over short period of time to make instant profits. The hedging strategy here would be writing futures contracts to sell brent oil at a certain price in the future over a shorter time period. Baggins Ltd. should also apply hedging strategies in USD-INR futures to earn extra profits. <<Add title>> • • • The data above shows a Monte Carlo simulation run on the prices of brent crude oil futures over the past 1 year. The Monte Carlo Simulation gives us a better idea of the market volatility we can face in crude oil prices. This model shows that there is a scope of loss of 300 to 400 INR at a 95% confidence level. • • From the simulation model we know that price changes aren’t consistent in the short run but they fall over a long period of time. The hedging strategy here would be writing futures contracts on brent crude oil with the expiry being over a large period of time. Limitations of Risk Management • Risk management strategies are highly dependent on historical trends and data which cannot give us an idea to deal with market volatility • In non quantifiable situations, lack of data can lead to severe causalities on risk interpretation. • Risk Management strategies followed not just by firms but also by huge banks can only predict events that are based on past market trends and cannot predict black swan events like the 2008 financial crisis. Inadequate Data Unpredictable Events Different Approaches Misallocation • There are numerous approaches to asses risk of a firm. • Taking VaR as an example, there are 3 different methods to find the VaR for returns on the same asset which can give 3 different values. • This inconsistency can create a lot of discrepancies for the risk assessors of a firm. • Subjective risk management strategies without quantifiable data can lead to allocation in different asset classes and can cause immense losses to financial institutions. • These risk management strategies also reduce confidence in the firm’s stakeholders on their gains. Geopolitical Risk • In order to measure geopolitical risk there are model given by Caldara and Iacoviello. • They proposed an indicator, the geopolitical risk (GPR) index, that spikes around geopolitical events, such as the Gulf War, the aftermath of 9/11, and during the 2003 Iraq invasion and how oil prices varied at that time. Volatility in markets due to geopolitical events since 1985 Integrating risk models in ERM Strategy Corporate restructuring Identifying uncertain elements • • Incorporating Risk models and implementation • After corporate restructuring, the market trends and volatilities are to be identified by the risk management team. Given the VaR and simulation model performed, all the hedging strategies are also to performed by the risk management team. After review of the financial statements by the internal auditor, further risk models and hedging strategies should be proposed to the board of directors. 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