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.
