5.3 Categorising risk Flashcards
A common approach to risk categorisation is to group organisational risks into which 6 categories?
business risk credit risk market risk liquidity risk operational risk reputation risk
What is business risk?
Non-financial risk relating to the positive and negative otucomes inherent in an organisation’s operating environment, such as action of competitors and political conditions.
Give some examples of business risks.
Actions of competitors Political conditions Economic conditions Changes in consumer demand Changes in regulation
Business risks can be grouped as i________ or e_______.
internal
external
How does Blockbuster demonstrate poor management of business risk?
Blockbuster did not adapt to customer demand.
Blockbuster was the leading provider of movie rental during the 1990s. The business refused an offer to buy Netflix for $50M in 2000 and ultimately went bankrupt in 2010 after failing to see the need to move to streaming from physical disk rental.
What is credit risk?
The risk that a borrower or counterparty will suffer a real or perceived deterioration of its credit rating, or an outright default, meaning they are unable to meet obligations.
In credit risk, exposure if measures as the amount of l____ that would be realized if a borrower or counterparty actually d_______.
loss
defaults
What is meant by “concentration” risk in the context of credit risk?
The risk that any single exposure has a potential to result in losses affecting the viability of an organisation - i.e. over-dependency on a single client
Credit risk specifically attributable to trading activities is called C________ C____ R___ (CCR), concerned with default on trading obligations such as derivative contracts.
Counterparty Credit Risk
Settlement risk is concerned with what?
The risk of a trading transaction not settling as per pre-agreed terms and conditions.
What is sovereign risk?
Risk of a sovereign government defaulting on debt obligations.
How does the Herstatt example provide a case study in credit risk?
Herstatt was a private bank in Germany, active in foreign exchange, which had a strong position betting against the US dollar. In 1974, the dollar strongly appreciated, leading to the bank’s liquidation. A number of US firms had paid large amounts to the after the liquidation but before they were notified of the liquidation, leading to large losses (and exposure to credit risk).
How can credit risk be managed?
Statistical models
Stress testing
Scenario analysis
Risk appetite and limits, including concentration limits
Credit underwriting and diversification standards.
What is market risk?
Market risk is the extent of change in the value of an investment due to changes in factors affecting the overall performance of financial markets.
Market risk is also known as what?
Systemic risk
The four major categories of market risk are: e\_\_\_\_\_\_\_ risk i\_\_\_\_\_\_\_ r\_\_\_ risk f\_\_\_\_\_\_\_\_\_ e\_\_\_\_\_\_\_ risk c\_\_\_\_\_\_\_\_\_ p\_\_\_\_\_\_\_ risk
equity risk
interest rate risk
foreign exchange risk
commodity price risk
V___________ is the key driver of market risk. It represents the degree of dispersion of returns for a given investment.
Volatility
How is volatility estimate in statistical terms?
Standard deviation
Market risk is primarily calculated using which method?
The value at risk method.
How may market risk be managed?
Statistical models Stress testing Scenario analysis Risk appetite and limits Diversification and hedging Qualitative assessments
There are two types of liquidity risk. What is asset liquidity risk?
An asset’s degree of liquidity, i.e. the inability to easily sell the asset.
There are two types of liquidity risk. What is funding liquidity risk?
The risk an organisation is unable to fulfil its payment obligations in a timely manner in normal or stressed market conditions.
How did Northern Rock exemplify liquidity risk?
Northern Rock expanded aggressively into residential mortgages, funded by short term overnight borrowing. Following the 2008 financial crisis, banks stopped lending to one another, locking NR out of the borrowing market. This spooked customers who withdrew savings, leading to insolvency and nationalisation of the bank.
What is operational risk?
The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events.
Operational risks are generally “pure” risks. What does this mean?
They only result in losses (no positive outcomes).
Provide examples of operational risks.
Fraud by staff, customers, or third parties.
Loss due to inadequate risk models
Damage to assets such as fire or flood
Business disruption such as strikes or power cuts
Health and safety issues
Customer service issues
Security breaches such as cyber attacks
What is regulatory compliance risk (a type of operational risk)?
The risk of failure to comply with laws and regulations, leading to penalties such as fines.
What is data quality risk (a type of operational risk)?
Risk of data used to calculate risk exposure being inaccurate.
What is reputation risk?
A strategic risk referring to risk of loss resulting from damages to reputation of an organisation, its brand, and perceived goodwill.
Why is reputation important for an organisation?
Good reputation leads to attracting more customers and higher-quality employees. It also contributes to lower marketing and financing costs.
How does the Ratner Group case study provide an example of reputational risk?
Ratner Group was a successful budget jeweler. At an IoD dinner at the Albert Hall, CEO Gerald Ratner made rash comments about the poor quality of his organisation’s products. Following this speech, the value of the Group plummeted by £500M.
Kaplan & Mikes (2012) developed an alterative risk categorisation framework segregating risks into three categories:
p___________ risks
s________ risks
e________ risks
preventable risks
strategy risks
external risks
What is a preventable risk, according to Kaplan and Mikes?
An internal risk faced by an organisation that is controllable.
What is a strategy risk, according to Kaplan and Mikes?
A risk assumed by an organisation willingly in pursuit of competitive advantage.
What is an external risk, according to Kaplan and Mikes?
A risk outside the organisation beyond the limits of its influence or control. e.g. political changes.
What are “internal control” risks?
Risks relating to failure of the processes, systems and controls that an organisation has in place to manage its employees and managers.
What were the facts of the LIBOR scandal?
Following the 2008 financial crisis, employees of Barclays Bank plc fraudulently manipulated interest rates reported under the London Interbank Offer Rate (LIBOR), to make the bank appear stronger than it was. This led to an increase in the LIBOR rate, which affected the credit interest rates on mortgages and other loans.
Barclays management were criticised for not having a stronger culture and internal control process to prevent such fraudulent activity. Barclays was fined a total of £390 million and the CEO and Chair resigned.
Risk c____________ is important to help organisations understand their risks. Organisations must decide how d_________ to make their subcategories. Too many make it difficult to categorise risks, too few and differences between risks may be missed.
categorisation
detailed
