Based on the above discussion, recommend and justify the risk exposures that should be reported as part of an Enterprise Risk Management System for the Toyota Motor Company? (10 Marks)
The first risk that Toyota is faced with is the investment in commodities. Commodities such as non-ferrous metals, precious metals, ferrous alloys, energy, and plastic resin from outside sources may be subjected to price changes. Changes in prices can have a negative impact on the productivity for Toyota because inflated prices may result in delayed projects and the inability to complete planned products based on a lack of resources. Another risk pertaining to commodities are regulator risks. Regulatory risk can be equivalent to “the impacts of perceived-or real- speculative trading and well-publicized abuses and losses associated with energy trading prompted enhanced US regulatory scrutiny of the markets” (LLP, 2009). The act of trading comes with the potential risks of inflated and over priced costs that come from the hands of differeent organizations that Toyota will be dealing with. For this reason, it is necessary to take various steps such as possible contracts that prevent the fluctiation of materials that are detrimental to production from negatively impating Toyota. In addition to inflated costs Toyota can also e negatively impacted by unforseen occurrence that impact their suppliers. In essence outside suppliers run the risk of changes in cost and a decline in production of metals and plastics used by Toyota to produce vehicles.
Commercial papers, term debt and lines of credit from major commercial banks all can expose Toyota to risks that are associated with each different form of financing. Commercial papers are unsecured promissory notes that Toyota received from various corporations. What this means is that the issuance of commercial payments is made in increments to the purchaser. Commercial paper is also a rolling form of debt that can present t the purchaser with credit risk, which are also rated by rating agencies. In other words if when Toyota uses commercial paper is they do not have positive credit rating not only will this discredit the organization, but it can also limit the opportunity to use other credit sources. Similar to a person with to many defaulted credit cards, the likelihood of getting a home are slim to none because of defaulting on previous financial obligations.
The risks that are associated with term debt are dependent on the type of term debt. Short-term debt requires the borrowing organization to pay back the borrowed amount with interest in 12-months. On the other hand long-term debt requires the company to pay back the debt over several years. The risk that lie in term debt stem from an organization’s inability to pay back the debt due to decline in productivity, or other financial challenges. This can result in delinquent payments and issues with the company’s rating from creditors as well. Lastly, lines of credit pose a potential to the organization because it is a business obligation. The structure of the organization plays a large part in the severity of the impact in regards to the line of credit liability.
The risks that are associated with the credit division at Toyota have recently became a matter of discrimination and recent lawsuits support this factor.
Discuss the type or types of risk that are inadequately managed in the above case? (5 Marks)
Interest rates with trading options are subject to the extensive regulatory risks due to the heavy regulation associated with OTC markets. The risks associated with volatility is the uncertainty. Volatility fluctuates and the past is not a reliable indicator of future benefits or vulnerabilities. Therefore, volatility is a potential risks for NWM. Due to the volatility NWM needs to base their prices on the current market opposed to past prices and costs. Lastly the issues associate with swap `of currencies is associated with the notional principal between the midpoint and end of the swap.
Discuss some risk governance concerns that are related to the above case? (5 Marks
The risk of governance associated with the NWM is the large magnitude of default credit will supersede the recovery rate. NWM made several decisions without conducting the proper risk assessment for each transaction. As a result, trading losses mounted in an interest rate option contract, a trader undertook a series of off-market-price transactions between the options portfolios and swaptions portfolio to transfer the losses to a type of contract where losses are easier to conceal.
Discuss the risk implications of the loss Scenario? Are there any reasons why the timing of the loss is particularly significant? (5 Marks)
The position in banking is significant to the contract and agreements that exist between the buyer and the seller. There are other definitions that provide an extensive rationale for what the position in banking truthfully means. The position is also the currency that is owed or borrowed. The owed currency is an indicator of a long position because the purchaser is investing in stock or other long-term assets with the intention of an increase in value. On the contrary the short position occurs when the “short seller identifies a security which he or she thinks is about to fail in price. The share is purchased and sold at the current price. If the price fails the share is repurchased at a lower price and the share is returned to the broker. In the case study it is evident that the trader operated outside of the contractual agreement that it had established with the bank by and the trader were violated. Trading stocks that have yielded a substantial financial loss are beneficial to the trading organization if the organization is capable of selling the stock. The end results are taxable gains because trading gains are reduced and limitations are placed on tax liability.
What mistakes did senior management make? Explain how these errors can be corrected? (5 Marks)
The mistakes of the banking institution that were highlighted in the case study were not considering liquidity as a risk. Liquidity is a risk for banking institutions because of short-term obligations are not met then the debts will outweigh the capital that has been generated. The senior management based risk assessments solely on the expertise of trader’s risk allocation. This was a mistake because it was deemed as justifiable despite the capital loss the company endured, and the contract between the trader and bank did not appear to present an issue.
The trader statements were not justifiable. Though risk was access the conduct of business was not justified. The position alteration that occurred in this case study negatively impacted the organization and did not give them the opportunity to recover before the end of the year approached.
Discuss a problem with using the analytical or variance covariance method for determining the VaR of this portfolio? (5 Marks)
Using the analytical or variance covariance method for determining the VaR of this portfolio is difficult because of the unpredictability of volatility in this case study. The VaR is supposed to be an essential and applicable statistical measurement to achieve this but stocks do not yield consistent values.
Describe a situation in which an organization might logically select each of the three VaR methodologies? (5 marks)
All three Var methods may be selected buy an organization when all liquid assets have no values that can be characterized.
Compute the monthly VaR Stulz wants to estimate for the Stimson portfolio? (5 Marks)
The estimated VarR that Stuiz wants to estimate for the Stimson Portfolio is as follows:
$50,000,000 x 1.65 x .18 = 1,485,000/12 = 123,750 monthly
Indicate whether the statements in the report that Stulz is preparing for Stimson Industries are correct or incorrect? Provide justification for your answers. (5 Marks)
Statements 2 and 3 are not determinable until the values are adequately calculated. The VaR is an estimate because the projected Var is simply an ideal of what the organization would like to yield. Statement 1 is accurate because the longer contract holder is subject to credit risks that are associated with up fronting the collateral costs if the other party defaults on the agreement payments. Statement 2 indicates that the VaR will be greater at a confidence level of 5% opposed to 1%. In the example if this is applicable it is indicating that the potential risk or earnings will be 5% of 50,000,000 = 250,000 or 1% = 500,000. So from a risk perspective statement 2 is accurate, but coincide again the VaR is merely a projection and is not definite.
Regarding Alton’s two derivative positions, is Kaiser correct about which party is bearing the credit risk of the currency forward contract and the put option on the DJ Euro STOXXX? Justify your answers (5 Marks)
Credit bond are bonds that are issued by corporations and is geared towards raising capital. These types of bonds are subject to market, liquidity, and credit risk (Jian & Zhao, 2013). The current closing cost is 295 but the amount that Alton Company is paying is higher than the closing cost therfore they are assuming the risk.
Suggest ways in which Kaiser can make the desired change in Alton’s credit risk? (5 Marks).
Taking an internal approach will allow Alton’s to assess their current credit risks to decipher which one yields the greatest success. After this is determined the most risky and less beneficial risk need to be eliminated. If you take 1.45/1.4 this is an indicator that the Euros apprecioated and the pounds depreciated. Because one pays less in euros to gain one pound. This means that Alton bears the risk because the company will owe their counterpart due to the aforementioned. The strike cost and closing costs also hold the risk for the long holder to lose money on the short sale to the customer.
Is Kaiser correct in predicting the independent effects of the increase in the expected return and the increase in the correlation, respectively, on the calculated VaR of the Muth portfolio? Justify your answers (5 Marks)
Kreuzer is not correct in predicting the effect of increase on the expected return, but he is correct in his assumptions about the expected effect of increase on the correlation. Given a VAR= Expected Return -1.65(Standard deviation), it must be considered that the higher expected return will actually decrease the VAR as it is relative to the original investment, so if the return is 100 percent, without an increased risk of return, the VaR must be lower than it is at 10%.
Are Kaiser’s statements about an advantage of VaR and about the Sharpe ratio, respectively correct? Justify your answers (5 Marks)
Yes her projections are correct. The Sharpe ratio has become the standards for calculating the adjusted risk return.
Calculate the £ value of the $15 million received in three months, assuming that the £:$ spot exchange rate in March is equal to:
Perform this calculation under the five different strategies that Ali considered. Discuss the relative advantages of the various strategies? (15 Marks)
The advantages of not hedging is reducing the risk that are associated with inflated cost associated with the exchange rate.
Assume that the investment horizon is one year and that there are no costs associated with currency hedging. State and justify whether Ali’s recommendation of not hedging the Japanese position should be followed. Show your calculations? (10 Marks).
With consideration to the interest rate parity, it can be calculated that the forward exchange rate is equal to ¥95.09£, because F = [1.06/1.008](1/100) = $0.010516/¥ = ¥95.09/£. When this rate is compared to Ali’s expected future spot rate of ¥98/£, it proves significantly lower. This means that the investment will earn a greater rate of return if they sell the Yen forward through hedging. Ali;s recommendation is incorrect because she underestimates the future strength of the Yen.
References
Jian, Q., & Zhao, Y. 2013. Risk Analysis for Corporate Bond Portfolios. Worchester Polytechnic Institute.
LLP, P. W. 2009. Navigation: Managing commodity risk through market uncertainty. Delaware: Price Water house CoopersLLP.
Spears, L. 2011. Stock Market End of Year Trading, Tax Loss Selling, Santa Claus Rally Effects. Available at: www.marketoracle.co.uk {Accessed July 1, 2016}
