Things occupying my mind :

• Revising the risk tolerance board paper proposal

Submitted to my immediate superior today the revised paper

• When is the re-scheduled RMC?

25 August tentative

Otherwise 28 September. Will we ever have a meeting?

• FRM Handbook - to get that moving and approved!

Good team discussion. Targeting 30th August, subject to BARRA procedures.

• FRS139 Classification reporting and application of the standard
• Working with FX on understanding the FX risk in the physical commodity flow
• FI credit limit configuration is TREMA
• BARRA initiatives
• Proposed FRM structure to address Group FRM
• Proposed Systems Implementation structure

Provided Khalil some ideas on his job responsibilities to be included in his PD.

Things occupying my mind :

1. Revising the risk tolerance board paper proposal
2. When is the re-scheduled RMC?
3. FRM Handbook - to get that moving and approved!
4. FRS139 Classification reporting and application of the standard
5. Working with FX on understanding the FX risk in the physical commodity flow
6. FI credit limit configuration is TREMA
7. BARRA initiatives
8. Proposed FRM structure to address Group FRM
9. Proposed Systems Implementation structure

Aligning FRM initiative with FX Management meeting

This morning FRM presented the RMC package on approaching Finance Risk from a group wide perspective to the FX Management team.

The central theme to this meeting was to discuss ways and means to achieve similar objectives. The key take away from this meeting, to my mind, is how FRM and FX Management can work together, share information and achieve the deliverable of identifying, assessing Finance Risk framework imlementation and FX risk profile for the Group to facilitate the management, reporting and mitigation of FX risk and the Finance Risk roll-out going forward.

As a start, we need to :

• compile a database of existing information and fact-finding to date, gathering resources from FX Management, Group Strategic Planning and perhaps Business Planner of each business line within PETRONAS Group.
• identify additional information that is required
• define how this database is to be developed and maintained
• who will be responsible to maintain this database
• standard templates required
• key deliverables for this is the information database and templates required before approaching OPUs

Developing the strategy in approaching OPUs need to take into consideration of :

• To what extent Corporate Risk has profiled risk for the OPU. This is to ensure that when Finance Risk approach OPU, we know the context of our approach vis-a-vis OPU overall risk management strategy
• To what extent is the Risk Management Framework addressed at each OPU
• What information resides at the Business level (Strategic Planning) before going into OPU details
• We need to have meetings with relevant parties ie OPUs, CRMU at this stage.
• Incorporate all this in the information database
• Key deliverable at this stage will be a current assessment report.

Once we have all this then we will need to define scope of finance risk coverage by :

• Define area of coverage ie physical commodity flow within PETRONAS Group
• Define coverage scope ie which physical commodity flow should we focus on Petchem? Oil? LNG? Domestic? International? We have to brainstorm on what makes sense.
• The information database to a certain extent may dictate the scope ie focus on where we have the most information
• Documenting the physical commodity flows
• Get the ball rolling then....roll-out, roll-out and roll-out!

Understanding the use of the square root of time to scale volatility

Time scaling of volatility

Discover how to scale standard deviation to different time horizons.

We know that risk increases with time: The longer we hold a position, the greater the potential loss. Following is a simple approximation to help you scale volatility estimates to a longer (or shorter) time horizon. Note, however, that this is just an approximation.

Volatility (or standard deviation) may be roughly approximated by scaling by the square root of time, assuming independent price moves. Note that we use the number of trading days (5 for 1 week, 21 for 1 month), as opposed to actual days to scale volatility.
Weekly volatility = daily volatility * sqrt(5) = daily volatility * 2.24
1 month VaR = 1 day VaR * sqrt(21) = 1 day VaR * 4.58

Intuitively, we can picture the square root of time scaling rule as follows: Imagine Zeus flipping coins every day--if heads come up, the stock market goes up, if tails come up, the stock market falls. Assuming 1% daily volatility (or standard deviation) in the markets, what would you expect weekly volatility to be?

We could just guess and multiply 1% by 5 to get 5%. However, it is unlikely (1/32 chance) that we'll have 5 bad days in a row, because every day's coin flip is independent--it has no memory of the past. An accurate prediction of a 5-day risk would 1% * square root of 5 = 2.24% (but only if Zeus is not biased!). Interested in why we use square root of time scaling?

Assumption

Square root of time scaling assumes independent price moves and constant volatility:
If there is significant mean reversion, time scaling will overestimate volatility (mean reversion is a statistical tendency to revert to a long-term average).
If there is significant trending, time scaling will underestimate volatility (trending is a statistical tendency to keep moving in one direction).
If volatility changes over time, or there are jumps, time scaling will be inaccurate.

Why use square root of time scaling?

From statistics, we know that we can aggregate the volatility of an independent process using the square root sum of the squares rule:

Total Std Dev = square root (Std Dev_1^2 + Std Dev_2^2 + .... + Std Dev_n^2)
Example

As a USD-based institution, you hold a 10-year JPY government bond. You are exposed to both FX and interest rate risk. The following are daily volatilities (1.65 standard deviation), according to RiskMetrics data on June 3, 1998, for interest rate and FX risk:

Price volatility of bond (interest rate risk) 0.38%
Volatility of JPY/USD (FX risk) 1.03%

Square root sum of the squares rule

Using the square root sum of the squares rule, total estimated risk assuming independence between FX and interest rate moves is as follows:
Estimate of total volatility = square root (0.38%^2+1.03%^2) = 1.1%. This means that we expect to lose 1.1% or more once every 20 days.
Using the RiskManager software to calculate, we get an almost identical VaR estimate:

In this case, assuming independence evidently did not sacrifice much accuracy (actual correlation between JPY/USD and 10-year bonds was 0.0185, or almost 0).

Continuing the coin flipping example, because risk is independent each day, we can use the square root sum of the squares rule to aggregate risk every day.
5-day risk = square root (day1 risk^2 + day2 risk^2 + day3 risk^2 + day4 risk^2 + day5 risk^2).
Assuming risk stays constant every day, we can simplify the expression as square root (5*day1 risk^2) = day 1 risk * square root (5).

Risk Management Quotes


What we anticipate seldom occurs; what we least expect generally happens.
Benjamin Disraeli 1804-1881, British prime minister and novelist

Wise men say, and not without reason, that whoever wished to foresee the future might consult the past.
Machiavelli 1446-1507, Italian statesman and philosopher

The first percept was never to accept a thing as true until I knew it was such without a single doubt.
René Descartes 1596-1650, French rationalist philosopher and mathematician

It is not because it is so difficult that we do not try something, it is because we do not try that makes something so difficult.
Seneca 4BC-65AC, Roman writer and moralist

However good our futures research may be, we shall never be able to escape from the ultimate dilemma that all our knowledge is about the past, and all our decisions are about the future.
Ian Wilson, American scenario planning expert and strategy consultant

Risk comes from not knowing what you`re doing.
Warren Buffett 1930-, American Investment Entrepreneur

Preparing for Risk Management Committee meeting - 3 August 2006

Nik Nira had sent me a list of items to be amended in the RMC package that was presented to the Finance Risk Council (FRC) on July 25th and for the package to be ready by Friday 4 August.

I wanted to cut down the presentation slides, particularly on the risk tolerance proposal. I have been a bit (if not a lot) out of focus lately, what with me being sick. So many things on my mind that needs attending to. Requested for submission on Monday 7 August instead first thing in the morning. Only to find out on Friday that the RMC meeting has to be postponed on account that Puan Mariah has to go to Pasir Gudang that day?? Yep, you better believe that.

In a way that was a relief, I can buy some time to finalise the RMC package. Still I brought back my notebook home so that I can do some work over the weekend.

Roadshow to PFK, Gurun, Kedah

Visit to PFK, Gurun - 1 August 2006

This trip was my first involvement in the Treasury road show, not counting the meeting that I had attended with PICL Egypt (and missing the one with MISC, Zarif was sick that day). We had flew into Penang on 31 July 2006 and stayed overnight at Trader's Hotel smack in the middle of Georgetown.
The next day, a van had been arranged to take us from Penang to Gurun, which took about an hour and a half or so. Ali had been to Gurun before, so he was the van driver's guide to PFK whereabouts. PFK office is adjacent to Naza automotive center. Wow...so many Naza cars parked in the yard surrounding the Naza building.

Azhar Ahmad (Senior Manager, Finance, PFK) greeted us as we arrived. After a round of introductions, we were led into their office where we left our baggage. Rosdi, the guy who had been so long in EMSB is now there. So is Taran Jeet! The plant visit was supposed to take place at 11am, so we headed to their canteen and had drinks.

The plant visit was conducted by Toslan, Senior Manager, Plant Ops. I don't really know what to narrate on the plant visit, sufficient to say that PFK's end products are urea, ammonia and methanol. The plant visit was conducted with us in the bus anyway. We saw that most people ride the bike going in to the plant. Plant safety -- no handphones and cigarette lighters allowed in the plant.

I feel that the atmosphere at PFK (or maybe any OPU in general that is not located in KLCC) is one that is relaxed and away from the hustle and bustle of corporate life as I know it. Hardly the conclusion for a half-day visit, I know.

Lunch was provided at the canteen. Group Insurance, who had an earlier meeting with PFK, was at lunch with us, too.

Key take away from the meeting

1. Definition of terms used is a must (after gauging OPU's level of awareness and understanding of Treasury terms and operations. The attendees from PFK came from diverse backgrounds (not necessarily finance) and there were many questions on what the terms meant. In fact PFK had requested for training in Treasury Management in general.
2. Able to relate presentation slides to practical examples that OPUs can understand.
3. On identification of OPU FX exposure and its relationship with its marketing agent ie MITCO, to discuss with FX Management on how FRM can contribute to this initiative.
4. FRM to include a slide or two describing its services and capabilities.

The meeting ended at about 5pm and we adjourned to the canteen again for tea.

Cabs were waiting for us in front of the PFK building and alas! it was time for us to leave. After good-byes, we left Gurun for Alor Star.