Advanced RAM Methodology Overview

The Advanced Risk Analysis Module (RAM) is a sophisticated software methodology that calculates performance bond requirements by analyzing the “what-ifs” of virtually any market scenario.

Continually enhanced and elaborated, the RAM methodology can be used to evaluate risk for the broadest possible range of derivative and physical instruments. It is extensive used in assessing risk for many different types of financial instruments.

RAM methodology is the performance bond/margin mechanism of more than 50 clearing organizations, service bureaus, and agencies throughout the world. The RAM software is utilized by a wide range of end-users, including merchants, banks, hedge funds, research organizations, risk managers, brokerage firms, and individual investors worldwide.

 

How the RAM Works

The RAM software evaluates portfolio risk by calculating the worst possible loss that a portfolio of derivative and physical instruments might reasonably incur over a specified time period (typically one day). This is done by computing the gains and losses the portfolio would incur under different market conditions.

At the core of the methodology is the RAM risk array, a set of numeric values that indicate how a particular contract will gain or lose value under various conditions. Each condition is called a risk scenario. The numeric value for each risk scenario represents the gain or loss that particular contract will experience for a particular combination of price (or underlying price) change, volatility change, and decrease in time to expiration.

 

RAM Parameters

Users may determine for themselves the following parameters, reflecting their desired degree of risk coverage:

– Price ranges (Price risk) – the maximum price movement reasonably likely to occur for each instrument or, for options, their underlying instrument

– Volatility ranges – the maximum change reasonably likely to occur for the volatility of each option’s underlying price

– Intra-commodity spread – rates and rules for evaluating risk among portfolios of closely related products, for example products with particular patterns of calendar spreads

– Inter-commodity spread – rates and rules for evaluating risk offsets between related products

– Delivery (spot) risk – rates and rules for evaluating the increased risk of positions in physically-deliverable products as they approach or enter their delivery period

– Short option minimum risk – rates and rules evaluating the irreducible minimum risk associated with portfolios of deep out-of-the-money short option positions.

At least once every business day, each Company’s Division or Clearing using the RAM calculates risk arrays for all of its products and prepares a risk parameter file (also called a RAM array file) containing all of the above data. These files are then published to clearing agents and other market participants. Using these freely-available files and our software, calculating performance bond requirements for portfolios is quick and easy.

 

RAM Combined Commodity Evaluations

The RAM divides the instruments in each portfolio into groupings called combined commodities. Each combined commodity represents all instruments on the same ultimate underlying – for example, all futures and all options ultimately related to the S&P 500 index.

For each combined commodity in the portfolio, the RAM evaluates the risk factors described above, and then takes the sum of the risk, the intra-commodity spread charge, and the delivery risk, before subtracting the inter-commodity spread credit. Then, it compares the resulting value with the short option minimum; whichever value is larger is called the “RAM risk requirement”. The resulting values across the portfolio are then converted to a common currency and summed to yield the total risk for the portfolio.

 

The RAM Product Suite

RAM is a suite of 3 software products designed to meet the needs of a wide range of customers: PC-RAM users, RAM Risk Manager, and RAM Risk Manager Clearing.

 

1. PC-RAM

The PC-RAM software, a single-user desktop application that offers margin calculation across multiple divisions, provides a quick, inexpensive, and simple way to calculate margin requirements.

2. RAM Risk Manager RAM Risk Manager integrates risk management features with core margin calculation abilities to deliver a flexible and intuitive system for full portfolio risk management. Its powerful features and intuitive design allow for true portfolio analytics through multi-variant stress testing and option exposures.

– Enables users to gauge the effects, on a total portfolio or a single option, of changes in price, implied volatility, time to expiration, dividend yields, and interest rates

– Calculates hypothetical P&Ls, option prices, and option greeks

– Calculates option implied volatilities, allows determination of appropriate volatilities for call/put pairs, and determines volatilities applicable to entire series of options

– Allows for stress testing across portfolios of multiple products

– Allows users to define, compare, save and reload “what-if” scenarios for stress testing

– Enables shifting of volatility skews – Supports a variety of pricing models applicable to different types of products

3. RAM Risk Manager Clearing

Our most powerful product, RAM Risk Manager Clearing is a program used by clearing organizations, service bureaus, and various agencies. It provides all capabilities of the PC-RAM software and RAM Risk Manager, and adds features enabling agencies and clearing organizations to implement the RAM methodology in a rapid and cost-effective manner.