FRE 517 (1.5) Futures Trading in Agricultural Commodities 2017 W2

Assignment – Risk Manager

For this assignment, you are asked to play the role of a Risk Manager in a trading team. Your trading team has been given $100,000 of capital to make a fortune trading a variety of futures contracts over the next 6 weeks. As a Risk Manager, your role is to identify, evaluate, and articulate the risks associated with the positions that your team’s portfolio manager and analysts want to take. In particular, your value-add to the team is in pointing out where the risk is worth taking and where it isn’t. You are also expected to be able to highlight risks that your teammates haven’t been paying attention to. You are expected to come up with a risk management process that protects your team.

You are expected to submit a write-up and also give a short presentation of your ideas (5 min) in the next class.

You are encouraged to build on and draw on your material from other classes (such as 501 and 502), to build on your fundamental understanding of commodities and futures trading.

In particular, you are expected to answer these questions:

  1. Start by identifying and describing the risks that your team will face
  2. Margining – how does the futures exchange set margin requirements for contracts? How does this affect your team’s trading strategy and risk?
  3. Is there good risk vs. bad risk?
  4. Propose some trading limits and position limits for your team with explanation

Additional helper questions:

a)Market participants usually face price risk, counterparty risk, liquidity risk. What other ways can you think of that could result in losses for your team?

b)Margining – different contracts require different levels of margin. Are there contracts that are more capital efficient? For example, if you expect a 1 week move of 5% in both Corn and Gold, which position should you put on from a capital-efficiency perspective?

c)Good vs Bad Risk:

  1. Are there trades that are highly correlated?
  2. If two trades have the same expected return but different risk profiles, which do you choose?

d)Trading limits and positions:

  1. Funds sometimes have multiple portfolio managers with multiple sets of books (portfolios). What do you think are the pros and cons of such an approach? Is this appropriate for your team?
  2. Should your team trade intra-day or hold positions for longer?
  3. Limits: How would you choose position limits for your team? By exposure to contract (notional)? By margin used?
  4. Limits: How much would you allow your team to trade daily / weekly?