Risk Mechanics
Financial derivatives - finding and fixing risk holes
This page describes the first edition of Risk Mechanics, published 1997. The second edition will be published in November 2008.

Second edition
To request price and availablity of the second edition contact:

ralph at bigpulse.com
Ph +612 9953 3958.   

The Origin of Risk Bombs
In 1996 Ralph McKay, author of Risk Mechanics, published a report in Euromoney's Corporate Finance dedicated to exposing serious flaws in the industry risk measurement standard VaR (Value at Risk). He warned VaR increased systemic risk and exposed the financial system to a massive risk Tunguska event. The 2008 risk bomb was the Tunguska event he predicted. Read his October, 2008 comment on the crisis, The Origin of Risk Bombs.

Risk Mechanics is the first "how to" book written for derivatives professionals. It is neither simplistic nor unnecessarily theoretical. This book reveals for the first time many practical secrets known previously to an elite few. These include techniques such as the new Dimensionless Risk and related fundamental risk numbers such as spotik, voltime and valspot along with Multirisk, AAA Hedge, bin technique and many subtle forms of information such as gamma smiles.

Most professionals will be suprised how easy it is to discover hidden risk holes in many of their most basic risk calculations. For example, 10 sources of possible error are identified in the market risk calculations of a simple FRA. The risk techniques explored provide a "risk tool box" from which solutions to a vast number of practical everyday risk problems can be devised.

Risk Mechanics, written by the inventor of the Universal Risk Machine, is the one that many professionals have been waiting for and yet some others hoped would never be published. It is a practical user guide for derivatives risk managers, particularly bankers and risk auditors as well as those aspiring to work in the derivatives industry.



Contents
    About this book  
    Derivatives and risk  
    Greek Letters, PV risk measures and VaR
CHAPTER 1  
PV Risk Components  
    FRA PV and risk components  
    Forming the nudge  
    Different uniform shifts  
    FRA risk - 10 point check list  
    Option PV and risk components  
    European option pricing formula  
    The Black formula and pricing interest rate options  
    Option valuation using yield  
    Option valuation using price  
    Option on FRA - PV risk components  
    Price and yield volatility conversion  
    Option yield risk  
    Option volatility risk  
    Option time risk  
    FRA linear price behaviour  
    FRA yield risk - near linear  
    FRA time risk - near linear  
    Option non-linear and local linear price behaviour  
    Option yield risk - near linear and non-linear  
    Option time lapse and volatility - near linear and non-linear  
    Netting PV risk components  
    Option/FRA convergence  
    Volatility: symmetric and asymmetric derivatives  
    Risk scaling  
    Summary
CHAPTER 2  
Greek Letter Risk Components  
    Mathematical Greek Letters  
    Greek Letter definitions  
    FRA Greek Letters  
    Option Greek Letters  
    Forming approximate Greek Letter derivatives  
    The rho Greek Letter for FRAs and options on FRAs  
    Summary
CHAPTER 3  
Delta Hedging  
    Option delta hedging  
    Hedge gamma risk  
    FRA contract rate and delta  
    Delta hedging - yield, volatility and time risk  
    Option replication  
    Dynamic delta matching  
    Summary
CHAPTER 4  
Dimensionless Risk  
    Dimensionless numbers  
    Risk similitude  
    Put/call symmetry - put option risk from the call algorithm  
    Summary
CHAPTER 5  
Multirisk, Risklock and AAA Hedging Techniques  
    Bumps in the risk carpet  
    Delta, gamma matching  
    Delta, gamma, vega matching  
    The AAA hedge  
    Summary
CHAPTER 6  
Forward/Futures Relationship  
    The marked-to-market effect  
    FRA/future delta hedging  
    Smiles and frowns - zero delta with gamma  
    Summary
CHAPTER 7  
Cashflow Risk and Hedging  
    Representing instruments as cashflows  
    Cashflow present value risk  
    Hedging cashflows with futures  
    Hedging cashflows with a futures strip  
    The forward/cashflow relationship  
    Macaulay and modified duration  
    Duration problems  
    Dimensionless cashflow sensitivity charts  
    Gamma risk  
    Convexity  
    Time lapse risk  
    Summary
CHAPTER 8  
The Bin Technique and Term Structure Hedging  
    Term structure risks  
    The bin technique  
    Placing the bin walls  
    Cashflow bin hedging using forwards  
    The empty bin trap  
    Summary
CHAPTER 9  
Bond Sensitivity, Duration and Hedging  
    Bond pricing  
    Bond delta  
    Bond gamma  
    Bond convexity  
    Bond yield sensitivity  
    Duration delta hedging  
    Hedging bonds with futures and forwards  
    The duration/volatility relationship  
    Summary
CHAPTER 10  
Replicating, Hedging and Modifying Swaps Caps and Floors  
    Manufacturing risk and flexibility  
    Manufacturing interest rate swaps from futures  
    The smile effect and basis equilibrium  
    Synthetic adjustment of cap/floor strike rate  
    Manufacturing catastrophe insurance  
    Summary
CHAPTER 11  
Benchmarks and Riskmarks  
    Payoff benchmarks  
    Risk reshaping  
    Flat benchmarks  
    Asymmetric benchmarks  
    Performance measurement  
    Summary
CHAPTER 12  
Pricing Formula - Summary  
    Cashflow present value  
    FRA valuation  
    Macaulay's duration  
    Cashflow portfolio sensitivity  
    European option pricing  
    Bond price  
    Volatility estimation  
    Interest rate parity
First Risk Olympics - Heat I  

Lists of Exhibits  

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