Audit Reports Affecting Multiple Agencies
Briefing Report on Derivative Investments by Texas State Entities
Report Number 95-035
The high concentration of volatile mortgage derivatives in
investment portfolios creates the risk that future liquidity
problems could occur. Derivatives held by six universities and
two junior colleges have market values ranging from 34 percent to
over 50 percent less than book values at July 31, 1994. Odessa
College has experienced liquidity problems. Five entities have
more than 60 percent of their portfolios invested in mortgage
derivatives, the majority of which are highly volatile. In
addition, two other universities and one junior college have 34
to 44 percent of their total investment portfolios in the same
types of derivatives.
Inadequate diversification of investment portfolios increases the
risk that liquidity problems could occur. The lack of adequate
portfolio diversification is caused by three major factors: (1)
lack of good management controls over the investing function, (2)
investment personnel's heavy reliance on brokers and dealers in
making investment decisions, and (3) pressures on investment
personnel to produce more income.
Total derivative investments account for less than 10 percent
($6.5 billion) of the total investments ($74.6 billion) of all
entities reporting derivatives.
More than 92 percent of the derivative investments, or about $6
billion, are in the State's largest portfolios. The level of
investment in derivatives at these entities appears reasonable in
the context of their total portfolios.
Derivatives are financial instruments (security or contract)
whose value is linked to, or "derived" from, changes in interest
rates, currency rates, and stock and commodity prices.
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