Part 1: Private banking 1<br/>1 Private banking defined 3<br/>1.1 Introduction 3<br/>1.2 Private banking clients 4<br/>1.3 Organizational challenges in private banking 7<br/>1.4 Security and secrecy requirements 10<br/>1.5 A private banking roadmap 12<br/>1.6 Household debt and private banking 15<br/>1.7 The ownership society’s recycling pattern 18<br/>1.8 Synergy of private banking and institutional investments 20<br/>2 Know your customer and his or her profile 24<br/>2.1 Introduction 24<br/>2.2 The sense of ‘know your customer’ 25<br/>2.3 A system approach to wealth management 28<br/>2.4 Wealth management according to client profile 32<br/>2.5 Why knowledge engineering can assist the investor 34<br/>2.6 A financial advisory expert system for currency exchange 37<br/>2.7 Caveat emptor and reputational risk 40<br/>2.8 Who is accountable for failures in fund management? 43<br/>3 Business opportunity: fees and commissions from private banking 46<br/>3.1 Introduction 46<br/>3.2 Trades, investments and private banking customers 48<br/>3.3 Establishing a strategy for fees and commissions 51<br/>3.4 Unbundling the management fee 54<br/>3.5 Different companies have different private banking aims 57<br/>3.6 Performance and remuneration of investment managers 59<br/>3.7 Simulation of portfolio performance 62<br/>3.8 The impact of business risk 65<br/>4 Risk and return with investments 68<br/>4.1 Introduction 68<br/>4.2 Basic notions of risk assessment 69<br/>vi Contents<br/>4.3 Mitigating the risk of losses 72<br/>4.4 Prerequisites for rigorous risk control 75<br/>4.5 Fine-tuning the philosophy of investments 78<br/>4.6 Risk and return with implied volatility 81<br/>4.7 Risk-adjusted pricing: an example with credit risk 84<br/>4.8 An introduction to stress testing 86<br/>Part 2: Asset management 91<br/>5 Asset management defined 93<br/>5.1 Introduction 93<br/>5.2 Asset management and capital mobility 95<br/>5.3 Asset allocation strategies 97<br/>5.4 Asset allocation and the shift in economic activity 101<br/>5.5 Real estate property derivatives: a case study 103<br/>5.6 Passive and active investment strategies 106<br/>5.7 A critical view of alternative solutions 110<br/>5.8 The portfolio’s intrinsic value 112<br/>6 Business models for asset management 116<br/>6.1 Introduction 116<br/>6.2 Choosing the investment manager 118<br/>6.3 Don’t kill the goose that lays the golden egg 120<br/>6.4 The contribution to asset management by contrarians 123<br/>6.5 Asset management as an enterprise 126<br/>6.6 Hedging strategies followed by portfolio managers 129<br/>6.7 Deliverables and performance in administration of assets 132<br/>6.8 Past performance is no prognosticator of future results 134<br/>7 Outsourcing and insourcing wealth management 138<br/>7.1 Introduction 138<br/>7.2 Risk and return with outsourcing 140<br/>7.3 Internal control and security are not negotiable 142<br/>7.4 Custody only, mid-way solutions and discretionary powers 144<br/>7.5 Building up the investor’s portfolio 148<br/>7.6 The option model of investing 152<br/>7.7 Efficiency in private banking and asset management 154<br/>7.8 The private banking profit centre 158<br/>8 Trust duties and legal risk 163<br/>8.1 Introduction 163<br/>8.2 Trusts and trustee responsibilities 164<br/>Contents vii<br/>8.3 Legal risk and the case of tort 167<br/>8.4 Reasons behind legal risk and cost of litigation 170<br/>8.5 Legal risk and management risk correlate 172<br/>8.6 Mishandling the client: small cases that can lead to legal risk 176<br/>8.7 Big cases of legal risk: high-tech crime and identity theft 178<br/>8.8 Merck and Co.: legal risk with Vioxx 180<br/>Part 3: Derivative financial instruments, structured products and<br/>risk control 183<br/>9 Derivative financial instruments defined 185<br/>9.1Introduction 185<br/>9.2 Derivatives and hedging 186<br/>9.3 Underlying and notional principal amount 189<br/>9.4 From notional principal to financial toxic waste 193<br/>9.5 Derivatives that became institutionalized 197<br/>9.6 Private banking derivatives and the paper money trauma 199<br/>9.7 Dr Alan Greenspan on derivatives and the case of<br/>hedge funds 202<br/>9.8 George Soros on derivatives 206<br/>10 Structured financial products 209<br/>10.1 Introduction 209<br/>10.2 Structured products and capital protection 210<br/>10.3 Structured versus synthetic products 213<br/>10.4 The role of strategists, traders and modelling controllers 216<br/>10.5 Aftermath of design factors on risk profile 219<br/>10.6 Structured investments are not liquid 222<br/>10.7 A secondary market for structured instruments 225<br/>10.8 Dynamic threshold mechanism 227<br/>11 Controlling the risk taken with structured products 229<br/>11.1 Introduction 229<br/>11.2 Credit risk and exposure at default 231<br/>11.3 Credit risk transfer and hazard rate models 234<br/>11.4 Credit risk volatility and bond spreads 237<br/>11.5 A case study on General Motors 241<br/>11.6 Liquidity risk in an ownership society 243<br/>11.7 General and specific market risk 245<br/>11.8 Stockmarket bubbles and damage control 248<br/>11.9 Risk management and the ‘Greeks’ 250<br/>viii Contents<br/>Part 4: Case studies with the three main classes of structured products 253<br/>12 Fixed income structured products 255<br/>12.1 Introduction 255<br/>12.2 Fixed interest structured products defined 258<br/>12.3 Constant proportion portfolio insurance 261<br/>12.4 FISP versus CPPI: a comparative study 264<br/>12.5 Borrowing through issuance of derivatives 266<br/>12.6 Capital protection notes and bondholders’ risk 270<br/>12.7 Structured instruments with underlying credit risk 273<br/>12.8 Embedded derivatives for the ownership society 276<br/>13 Practical examples with fixed income derivatives 279<br/>13.1 Introduction 279<br/>13.2 Money rates, money markets and financial instruments 281<br/>13.3 Inflation-linked notes 284<br/>13.4 Stairway notes (step-ups) 288<br/>13.5 Callable reverse floaters 290<br/>13.6 Accrual notes 293<br/>13.7 Fixed and variable rate notes 296<br/>13.8 Bull notes 297<br/>14 Equity-type structured products 300<br/>14.1 Introduction 300<br/>14.2 Headline risk and the nifty-fifty 303<br/>14.3 Equity derivatives defined 306<br/>14.4 Players in equity derivatives 309<br/>14.5 Risks taken with analytics 311<br/>14.6 Criteria used for dynamic rotation 315<br/>14.7 Equity derivatives swaps 316<br/>14.8 The use of embedded barrier options 318<br/>15 Practical examples with equity-type derivatives 322<br/>15.1 Introduction 322<br/>15.2 Equity index and basket structured notes 324<br/>15.3 Absorber certificates 326<br/>15.4 Early repayment certificates 328<br/>15.5 Enhanced yield certificates 330<br/>15.6 Reverse exchangeable certificates 331<br/>15.7 Potential share acquisition certificates 332<br/>15.8 EUR complete participation securities 334<br/>15.9 US dollar non-interest-bearing note linked to equity 336<br/>15.10 The strategy of pruning the basket and reallocating securities 336<br/>Contents ix<br/>16 Currency exchange structured products 338<br/>16.1 Introduction 338<br/>16.2 Currency transactions and economic exposure 340<br/>16.3 Exchange rate volatility and risk control 343<br/>16.4 Mismatch risk and carry trades 346<br/>16.5 Forex rates and structured instruments 349<br/>16.6 Dual currency structured products 352<br/>16.7 A US dollar/Asian currency basket and a forex benchmark fund 354<br/>16.8 Conclusion 357<br/>Appendix Derivatives as a tax haven 359<br/>A.1 Introduction 359<br/>A.2 Wealth tax 359<br/>A.3 Derivatives, offshores and private individuals 361<br/>A.4 Companies have been masters in using derivatives and offshores 362<br/>A.5 Shifting the risk with no return to the household sector 364<br/>A.6 Cynics look at the private banking client as a cash cow 366<br/>Index 369<br/>