The use and application of options in a bank

Abstract

Derivatives and options in particular had received a bad publicity, mainly due to the substantial losses suffered by banks in particular. This dissertation starts off with a description of the four types of options that one may find. Since options may be used both for hedging and as well for speculation, the risks involved are listed in every case. In fact the two parties to an option i.e. a writer and a holder are mentioned and practical examples are also included. The author tried to unfold the complex issues in connection with trading strategies by explaining each strategy taking into account its risk profile together with the maximum gain or loss possible. Guidelines for end users have also been drafted as to the proper use of options. The role of the board of directors has been given its due importance since throughout the use of these instruments it is a common fact that unfortunately the board is not well informed of what the risks that their treasury department is exposed to. Therefore items like risk management, policies and procedures, supervision of activities and credit risk are discussed and evaluated. The dissertation concludes with a representation of three surveys, the first held locally by the author of this dissertation, the other two were held abroad by other institutions. The scope for the local survey was to evaluate and gauge the awareness of the use of options in Malta. Whilst the scope of quoting the two foreign surveys was to highlight the use and misuse of such instruments in sophisticated financial markets. Finally after all the data and other documentation was collected, an advanced statistical tool called the paired T-test was used to evaluate the responses. Since the local sector was divided into various, comparison between one and an other was carried out. Then recommendations were written keeping in mind the limitations that the local sector has. A series of appendix may be found at the end of the dissertation with the scope of making these somewhat complex issues more realistic. In fact the Bloomberg services was used throughout to supplement the observations and comments.