Managing Risk With Derivatives: A Guide for Bankers and Their Customers.

• Author: Bohlen, Bruce D.

Reviewed by Bruce D. Bohlen, treasurer of The Port Authority of New York and New Jersey.

Townsend Walker's new book Managing Risk With Derivatives is intended as a tool for financial officers and other professionals who want to learn how to use derivative financial instruments to hedge interest rate exposure. Derivatives have proven to be a powerful tool for hedging interest rate exposure. Consequently, this up-to-date, thorough, and comprehensive treatment of this subject aimed at practitioners is a welcome addition to the literature.

Managing Risk covers subjects in both a general, informative level of detail and a technical and detailed manner, which benefits the hands-on practitioner. The organization and content of Managing Risk is first rate. Walker begins with a discussion of hedging policy and controls/reporting and moves through an insightful discussion of how interest rate exposure occurs in organizations. He follows this up with a discussion of quantifying the impact of exposure. Next comes a comprehensive discussion of hedging alternatives, including insights on how to select a suitable hedge. The balance of the book mostly discusses what most public finance officers would consider very complex hedging transactions, including permutations, utilizing derivative products.

Walker's book is particularly timely given that more than a few organizations, including some in the public sector, have experienced substantial losses on derivatives positions in the recent past. Managing interest rate risk in today's volatile markets is a complicated issue, and the powerful new tools available for managing such risks require an unprecedented level of sophistication on the part of users. For example, how many public-sector finance officers focus on asset/liability management concepts when thinking about hedging interest rate risk? If local finance officers, who in many instances have responsibility for liquid assets and the debt portfolio, do not evaluate both sides of the balance sheet, there is risk that a natural hedge may be undone by implementing a derivative position on one side of the balance sheet. Relegating asset/liability management to a single chapter is one of...