Summer Internship Report

At Edelweiss Financial Services

Submitted by
Jatin Gupta
2015PGP156

Edelweiss Group
Edelweiss group is a leading diversified financial services organization providing a broad range of
financial products and services to a substantial and diversified client base that includes corporations,
institutions and individuals.
Incorporated in 1995 as an investment bank with focus on Private Equity Syndication
More than forty different lines of business and subsidiaries today
Key businesses: Credit including Retail Finance, Agency businesses including Financial Markets,
Commodity & Agri Services and Asset Management, Life Insurance and Balance Sheet Management
Unit

FY15 Revenue of 39.12 bn, PAT of 3.29 bn

12 year CAGR for Revenue 64% and for PAT 73% upto FY15

9MFY16 Revenue of 37.77 bn, PAT of 2.93 bn

Guiding principles:

We will be a Thinking Organization

We will focus on the Long Term

We will be Fair to our clients, our employees & all stakeholders

Our Financial Capital is a critical resource for growth

We will focus on Growth

Our Reputation is more important than any financial reward

We will respect Risk

We will take care of our People

We will operate as a Partnership, internally and externally

We will Obey and Comply with the rules of the land

Long term value drivers:

Profitability
Scalability
Sustainability
Management Quality
Governance

Strengths:

Growth with Profitability

Diversified Revenue Streams

Strong & Liquid Balance Sheet

Strong Governance

Risk Management

Entrepreneurial, Leadership &

Innovation Culture

Technology

Customer centricity

Research & Data Analytics

Social Responsibility

Since the projects were confidential, they

are explained briefly

Title
Hedge Effectiveness in Asset Liability Management

Objective
Measure and improve Hedge Effectiveness in Asset Liability Management of Life insurance
Company and developing an automation tool

Key Deliverables

Automate the existing Risk Report calculations in Asset Liability Management of

Edelweiss Tokio Life Insurance
Understand the existing hedge effectiveness evaluation measure used in ALM of ET Life
Study other models for measuring hedge effectiveness

Methodology of Study
1.

Define hedging objectives

2. Select methodology for hedge effectiveness evaluation
3.
Evaluate hedge effectiveness
4.
Interpret effectiveness results

Hedge Effectiveness is the degree to which changes in the performance of an underlying,

in respect of the designated risk are offset by the changes in performance of the hedging
instrument

In Insurance liabilities are the underlying securities and assets are the hedging instrument

Prices of liabilities and assets are affected by Interest Rate changes

Hedge Effectiveness Evaluation
PROSPECTIVE TEST
Objective is to prove that hedge will be highly effective looking forward
RETROSPECTIVE TEST
To prove whether the actual hedging relationship was effective in the last period
HEDGE RATIO CALCULATION
-Change in value of assets to 1% change in interest rate/ Change in value of liability to
1% change in interest rate
The closer the hedge ratio is to 100%, better is our hedged position
Current Hedge Ratio maintained between 80% and 120%

Hedge Effectiveness Tests

Regression Analysis
Change in value of liabilities taken as the independent variable

Change in value of assets is the dependent variable

Slope should be negative and close to 1 for effective hedge
Statistical significance using t statistic

Risk Reduction Measure

Calculates the reduction of risk of the combined portfolio(Assets+Liabilities) wrt to

underlying(Liabilities)
Relative Risk Reduction = 1-(risk of portfolio/risk of underlying)
Measurement of Risk can be done using variance , value at risk or volatility

Scenario Analysis (Monte Carlo Simulation)

Provides multiple scenarios by estimating different paths of IR risk
Based on probability distribution of IR Risk
One of the paths might be the actual movement , will give a good prospective result
Duration : Linear measure or 1st derivative of how the price of a bond changes in response to
interest rate changes
Absolute Change in Price for 1% IR change = Modified Duration * Price
Duration & Convexity Matching

Duration matching can cover interest rate sensitivity

Parallel shifts in the interest rate curve can be captured by duration matching
Absolute levels of changes in Price of assets and liabilities might be different
Cannot accurately measure the tilts and bends and higher changes in the curve like
steepening and flattening
To measure tilts and bends and higher IR changes , Convexity can be used

Convexity : Non-linear relationship of bond prices to changes in interest rates, the second
derivative of the price of the bond with respect to interest rates
Matching convexity of Assets and Liabilities along with their Duration will give better absolute
results of Price change
Small & Parallel Interest Rate Changes
Calculate : Duration(Assets)*PV (assets) /Duration (Liabilities) *(PV liabilities):
Should be close to 1 to maintain hedged position
Replace an existing asset with another which moves this ratio closer to 1
Large/Non-Parallel Interest Rate Changes
Calculate : Duration(Assets)*PV (assets) /Duration (Liabilities) *(PV liabilities):
Calculate Convexity(Assets)*PV(Assets)/Convexity(Liabilities)*PV(Liabilities)
Both should be close to 1 to maintain hedged position
Replace an existing asset with another which moves these ratios closer to 1

Automate the existing Risk Report calculations in Asset Liability Management of Edelweiss
Tokio Life Insurance
Existing process

Manual Process
Requires a person equipped with ALM knowledge
1 week job
Chances of errors in manual process
Involves creation of many unnecessary intermediary files
Knowledge Transfer is lengthy

New process

Automated GUI based process

Operator requires minimum ALM knowledge
Effort reduced from 1 week to 2-3 hours
Chances of errors minimized
File creation minimized
Knowledge Transfer simplified

Get all inputs: assets, liabilities and yield curve from a GUI based method
Validate Inputs

Once all inputs obtained , get them in an understandable Model

Generate the final report from this model

Process Followed And Challenges Faced

Project required a tool which could provide GUI features as well as manipulating
excel sheets using macros
Macros were written to implement internally generated data
Tried out various languages like C++, Java
Python had the easiest Excel Manipulation options

Analysis/Achievements

Duration and Convexity Matching gives appropriate results for cash flow hedging
Monte Carlo Simulation takes care of all shortcomings of Regression analysis and VRM
method of hedge effectiveness

Conclusion
Hedge Effectiveness measures were suggested for ALM and the automation tool for the existing
method was developed.