1 Flashcards
Define Risk
The effect of uncertain future events on a company or on the outcomes the company achieves
Define Risk management
Risk management is an iterative process used by organisations to support the identification and management of risk (or uncertainty) and reduce the changes and/or effects of adverse events while enhancing the realisation of opportunities and the ability to achieve company objectives typically driven by its mission and strategy
Risk Management Process
Set objectives
Detect and Identify Events
Assess and Prioritise Risk
Aelect a Risk Response
Control and Monitor
Who is the head of the risk and who it reports to
Chief Risk Officer, board of directors
What is the role of Risk manager?
Assess, monitor and report on risks, and in some cases, they may have an approval function or veto authority.
It must ensure that are relevant risks are identified, but the final judgement lies with decision makers
What are Three-Lines-of-Defense
Employees and managers
Risk / Compliance management
Internal audit
Benefits of Risk management (8)
§Supporting strategic and business planning;
§ Incorporating risk considerations in all business decisions to ensure that the company’s risk profile is aligned with its risk tolerance;
§ Limiting the amount of risk a company takes, preventing excessive risk taking and potential related losses, and lowering the likelihood of bankruptcy;
§ Bringing greater discipline to the company’s operations, which leads to more effective business processes, better controls, and a more efficient allocation of capital;
§ Recognising responsibility and accountability;
§ Improving performance assessment and making sure that the compensation system is consistent with the company’s risk tolerance;
§ Enhancing the flow of information within the company, which results in better communication, increased transparency, and improved awareness and understanding of risk;
§ Assisting with the early detection of unlawful and fraudulent activities, thus complementing compliance procedures and audit testing.
What are the costs of Risk management?
§ tangible costs – hiring dedicated risk management personnel, putting in place procedures, and investing in systems,
§ intangible costs – slower decision making and missed
opportunities.
Define Market Risk
losses arising from changes in market-risk factors such as changes in interest rates, foreign exchange rates, or equity and commodity price factors
What are 4 types of Market Risk
§ Interest rate risk
§ Foreign exchange risk
§ Equity price risk
§ Commodity price risk
Define Interest rate Risk
the risk that the value of a fixed-income security will fall due to an increase in market interest rates.
Define Foreign exchange risk
arises from open or imperfectly hedged positions in a particular foreign currency leading to fluctuations in profits or values as measured in a local currency.
Define Commodity price risk
the risk that the value of a commodity will fall due to various factors specific to commodity markets (the concentration of supply, limited number of market players, etc.)
Define Equity price risk
the risk associated with volatility in stock prices.
What is refinancing risk?
the risk that the cost of rolling over or reborrowing funds will rise above the returns being earned on asset investments
What is reinvestment risk?
uncertainty about the interest rate at which it can reinvest funds borrowed for a longer period
What are 3 Interest Rate Risk management models?
Repricing model
Maturity model
Duration model
Define Repricing model
a book value accounting cash flow analysis of the repricing gap between the interest income earned on an FI’s assets and the interest expense paid on its liabilities
Define Repricing gap
the difference between assets whose interest rates will be repriced or changed over some future period and liabilities whose interest rates will be repriced or changed over some future period.
What are 4 weaknesses of Repricing Model?
Market value effects
Overaggregation
The problem of runoffs
Cash-flow from off-balance-sheet-activities
Define Refinancing Risk
The risk that the cost of rolling over or reborrowing funds will rise above the returns being earned on asset investments.
What is Macaulay’s duration?
the weighted-average time to maturity on the loan using the relative present values of the cash flows as weights and is measured in years since we weight the time (t) at which cash flows are received by the relative present value importance of cash flows.
2 ways FX rates are listed, explain them
§ Direct quote: domestic currency received for one unit of the foreign currency exchanged
§ Indirect quote: foreign currency received for each domestic currency exchanged
What are 2 types of FX transactions, explain them
§ Spot FX transaction involve the immediate settlement, or exchange, of currencies at the current (or spot) exchange rate.
§ Forward FX transaction is the exchange of currencies at a specified exchange rate which is settled at some specified date in the future.
What is Net positive exposure?
FI’s overall FX exposure in any given currency
