1.1 - Building Blocks of RM Flashcards
What are the four components of a risk management process?
Identify the risk, Analyze the risk, Assess impact of risk, and Manage the risk.
What are two types of liquidity risk?
Funding liquidity risk and trading liquidity risk.
What is meant by strategic risk?
Strategic risk involves making large investments and long-term decisions about the firm’s direction, affecting future growth and performance.
What is reputation risk?
The possibility of a firm suffering a sudden decline in market standing or brand value, leading to economic consequences.
What is counterparty risk?
The risk that the counterparty to a trade will fail to perform.
What drives market risk across all markets?
General market risk and specific market risk.
What is economic capital, and how does it contrast with regulatory capital?
Economic capital is the amount a firm needs based on its understanding of economic risks, while regulatory capital is determined using regulatory rules.
What does a daily VaR of USD 14 million at a 97.5% confidence level mean?
There is a 2.5% probability that the bank’s trading portfolio will lose more than $14 million in one day.
What are the key risk management building blocks?
Risk identification, expected/unexpected loss, structural change, risk factor breakdown, human agency, risk interactions, and ERM.
What are the four choices involved in classic risk management?
Avoid Risk, Retain Risk, Mitigate, and Transfer.
What is RAROC, and how is it calculated?
Risk-Adjusted Return on Capital (RAROC) is calculated as After-Tax Net Risk-Adjusted Expected Return / Economic Capital.
How does unsupervised machine learning help in risk management?
It helps identify “unknown unknowns” by detecting clusters and correlations without predefined assumptions.
Why did the Basel Committee change its approach to operational risk capital in 2016?
It moved towards a standardized approach based on bank size and past losses instead of complex analytical models.
What is the purpose of reverse stress testing?
To work backward from extreme loss scenarios to understand exposures and risk drivers.
What is the relationship between expected loss (EL) and loan parameters?
EL is calculated as Exposure at Default (EAD) × Loss Given Default (LGD) × Probability of Default (PD).
