HSBC 2003 Annual Report Download - page 170

HSBC HOLDINGS PLC
Financial Review (continued)
168
2003. In practice, the full amount of the proposed
dividend may not be paid out as shareholders can
elect to receive their dividend entitlement in scrip
rather than in cash. Short-term assets of US$12.9
billion, consisting mainly of cash at bank and money
market deposits of US$7.9 billion and other amounts
(including dividends) due from HSBC undertakings
of US$2.5 billion, exceeded short-term liabilities.
Market risk management
Market risk is the risk that foreign exchange rates,
interest rates, credit spreads, or equity and
commodity prices will move and result in profits or
losses to HSBC. Market risk arises on financial
instruments which are valued at current market
prices (mark-to-market basis) and those valued at
cost plus any accrued interest (accruals basis). The
main valuation sources are securities prices, foreign
exchange rates, interest rate yield curves and
volatilities.
HSBC makes markets in exchange rate and
interest rate instruments, as well as in debt, equities
and other securities. Trading risks arise either from
customer-related business or from position taking.
Trading positions are valued on a mark-to-market
basis.
In liquid portfolios, market values are
determined by reference to independently sourced
mid-market prices where it is reasonable to assume
the positions could be sold at those prices. In less
liquid markets and/or where positions have been held
for extended periods, portfolios are valued by
reference to bid or offer prices as appropriate.
For certain products, such as over-the-counter
derivative instruments, there are no independent
prices quoted in the markets. In these cases,
reference is made to standard industry models, which
typically utilise discounted cash flow techniques to
derive market values. The models may be developed
in-house or may be software vendor packages.
Where applicable, prices are amended if the
transaction involves an illiquid position, particularly
if its size is considered significant in comparison
with the normal market trading volume in that
product.
The vast majority of HSBC’s derivative
transactions are in plain vanilla instruments,
primarily comprising interest rate and foreign
exchange contracts, where market values are readily
determinable by reference to independent prices and
valuation quotes, as described above.
Occasionally, when standard industry models are
not available, and there is no directly relevant market
quotation, HSBC will develop its own proprietary
models for performing valuations. This situation
normally arises when HSBC has tailored a
transaction to meet a specific customer need. All
such models are checked independently and are
subject additionally to internal audit review on a
periodic basis to ensure that the assumptions
underlying the models remain valid over the lives of
the transactions, which are generally less than five
years.
The management of market risk is principally
undertaken in Global Markets through risk limits
approved by Group Management Board. Traded
Markets Development and Risk, an independent unit
within the Corporate, Investment Banking and
Markets operation, develops risk management
policies and measurement techniques, and reviews
limit utilisation on a daily basis.
Risk limits are determined for each location and,
within location, for each portfolio. Limits are set by
product and risk type, with market liquidity being a
principal factor in determining the level of limits set.
Only those offices which management deem to have
sufficient derivative product expertise and
appropriate control systems are authorised to trade
derivative products. Limits are set using a
combination of risk measurement techniques,
including position limits, sensitivity limits, and value
at risk limits at a portfolio level. Options risks are
controlled through full revaluation limits in
conjunction with limits on the underlying variables
that determine each option’s value.
Additionally, market risk related to the
residential mortgage business in the USA is primarily
managed by the mortgage business under guidelines
established by its Asset and Liability Policy
Committee.
Trading value at risk (‘VAR’)
VAR is a technique that estimates the potential
losses that could occur on risk positions as a result of
movements in market rates and prices over a
specified time horizon and to a given level of
confidence.