Another important distinction between futures and forwards is that the futures exchange guarantees to each party the performance of the other party, through a mechanism known as the clearinghouse. This guarantee means that if one party makes money on the transaction, it does not have to worry about whether it will collect the money from the other party because the clearinghouse ensures it will be paid. In contrast, each party to a forward contract assumes the risk that the other party will default.
An important and distinguishing feature of futures contracts is that the gains and losses on each party’s position are credited and charged on a daily basis. This procedure, called daily settlement or marking to market, essentially results in paper gains and losses being converted to cash gains and losses each day. It is also equivalent to terminating a contract at the end of each day and reopening it the next day at that settlement price. In some sense, a futures contract is like a strategy of opening up a forward contract, closing it one day later, opening up a new contract, closing it one day later, and continuing in that manner until expiration.
With online loans , you can easily access money when you need it most days or even weeks before your next paycheque arrives.
THE CLEARINGHOUSE, DAILY SETTLEMENT, AND PERFORMANCE GUARANTEE
ACCURACY OF CORPORATE LOSSES
Risk management is a hugely information-hungry process. Keeping an up-to-date record of banking or fund winners and losers is a data-intensive exercise. Completeness and the accuracy of the data are the bedrock for corporate scrutiny. Banks can be strange animals when it comes to releasing data; they may not even be fully aware of their own profitability. The new Basel II regulations will try to enforce mandatory reporting of profits and losses in detail. This is where the Basel II regulations come in to encourage more banking transparency. Losses are bad news, and sometimes nothing is worse than the embarrassment of a public loss or reputational damage.
A failure or degradation in these operations tends to make existing customers and counter-parties defect, resulting in an economic loss to the firm. Reputational effects are particularly important for larger more well-known retail banks in competitive markets whose customers can easily transact elsewhere.
Knowing how much you have lost, and why, is a sign that you are making progress in retailing. Knowing how to stop or reduce your losses is an indication of business success. These are known as “risk triggers”, while in auditing they are called “red flags”.
Adapting this sort of analysis would be useful in banking and fund management. Furthermore, on the larger corporate scale, banks under the stiffer Basel II operational risk measures will rarely wish to confess to the central banking authorities that they are “banks at risk”. Certainly, banks rated as more risky will be forced to pay higher operational costs in terms of a capital adequacy ratio of reserves held in the central bank under new Basel II rules. We can adapt one feature, the recording of losses, from the Basel II banking regulations and adapt it for the retail industry. This forms the first one-line building-block approach of our Basel II Loss Database for dealing with operational risk in the finance industry. This is a simple prototype approach towards identifying areas for monitoring, i.e. being risk proactive against solely reactive. It can identify business areas for improvement, certainly when you data-mine by business lines and deeper detail. This is a potentially rich area for business intelligence development.
CORPORATE MISGOVERNANCE
If the risk-averse investor continues to park good money with bad company directors, what can be done to protect the innocent? The investor has to be both reasonable and proactive. We have seen the pitfalls from the side of the financial experts who have lost investors’ money, partly from a lack of proper communication. This fault can come from both sides, either the salesperson “ramping” a financial instrument that is more risky (or much valuable) than is likely within the bounds of reality, or the investor having a risk appetite that is completely unsuitable. Furthermore, there is a problem with the regulatory moves to make self-disclosure best practice for the industry when the salespeople do not want to, or cannot, reveal the true extent of risk.
Regular people, not Wall Street professionals, have lost a collective fortune by relying on the tainted advice of the biggest and most trusted names in the world of finance.
As one Merrill Lynch analyst wrote:
We are losing people money and I don’t like it. John and Mary Smith are losing their retirement (money) because we don’t want . . . an investment banking client – the CFO of Goto.com to be mad at us.
We have to admit that a corporate gagging order, under many slogans (“Don’t rock the boat”, “Don’t tell the customer more than you have to” etc.), is likely to continue despite all legal moves for full disclosure. Faced with this scenario, it is incumbent upon the John and Mary Smiths of this world to take on the role of investigative investor and to evaluate the extant risk and fair valuation themselves. They should forget reputation and actively ask themselves whether the business opportunity offered really merits an appropriate investment.
What is more appropriate is that investors do not pass the investment mandate so readily to the “experts”, but consider the suitability risk. The suitability risk has been defined as: “The risk that the institution sells the client the ‘wrong’ product, which the client later claims to be inappropriate for its needs or level of experience.
Aristotle was asked what reason was. He gave examples of what reason was, and what a reasonable man would do under certain circumstances. This question still unsettles modern legal thinking two millennia after the Greek classics. The US Supreme Court employs the “reasonable man” hypothesis, to determine what a reasonable person would do under specific circumstances. Degrees of reasonable risk and reasonable return still trouble us today.
Determining a reasonable risk-return performance is a more dedicated and complex task than many banks have thought, even now. One view takes this task as a combination of three horizontal processes cutting across all business lines throughout the corporation:
1. Setting up risk-return guidelines and benchmarks.
2. Risk-return decision making (“ex ante perspective”).
3. Risk-return monitoring (“ex post perspective”).
It is time for the John and Mary Smiths of the investment world to extend their snouts and sniff out the risk themselves.
What has emerged over recent months is a renewed effort to force “corporate transparency” and disclosure. There are numerous moves to improve corporate governance and we track a handful of them. Will these moves drive the thieving or incompetent directors into the open? Faced with such corporate uncertainty, we need a risk management strategy to handle the potential danger. We compare this project initiation or remit according to the best practice in RAMP (risk analysis and management of projects). RAMP offers us the risk management actions to choose:
Avoiding risk
Reducing risk
Reducing uncertainty
Transferring risk
Insuring risk
Sharing risk
Nobody loves a loser, and there are few dealing operations in banking and fund management that would wish to appear anything less than a winner.