Ch. 4: Op, Fin & Strat Risk Flashcards
Six examples of strategies to mitigate people risk
Recruitment Selection Training and development Performance management Incentives Succession planning
Root cause (definition)
The event or circumstance that directly leads to an occurrence
Key risk indicator (KRI) (definition)
A financial or nonfinancial metric used to help define and measure potential losses
Exposure indicator (definition)
A metric used to identify risk inherent to an organization’s operations
Loss ratio (definition)
A ratio that measures losses and loss adjustment expenses against earned premiums and that reflects the percentage of premiums being consumed by losses
Control indicator (definition)
A metric used to identify an organization’s management of risk
Nine examples of risk indicators for people risk
Education Experience Staffing levels Employee surveys Customer service Compensation and experience benchmarked to industry Incentives such as bonuses Authority levels Management experience
Seven examples of risk indicators for process risk
Quality score cards Analysis of errors Areas of increased activity or volume Review of outcomes Internal and extra review Identification of areas of highest risk Quality of internal audit procedures
Six examples of risk indicators for systems risk
Benchmarks against industry standards Internal and external review Analysis to determine stress points and weaknesses Identification of areas of highest risk Testing Monitoring
The three major types of financial risk
Market risk
Credit risk
Price risk
Risk optimization (definition)
A state whereby risk and return are balanced so that a maximum return is achieved for the level of risk accepted by an organization
Hedging (definition)
A financial transaction in which one asset is held to offset the risk associated with another asset
Systematic risk (definition)
Risk that is common to all securities of the same general class and that therefore cannot be eliminated by diversification
The five major categories of market risk
Currency price risk Interest rate risk Commodity price risk Equity price risk Liquidity risk
Interest rate risk (definition)
The risk that a security’s future value will decline because of changes in interest rates
Swap (definition)
An agreement between two organizations to exchange payments based on changes in the value of an asset, yield, or index over a specific period
Cash matching (definition)
The process of matching an investment’s maturity rate with the amount of expected loss payments
Zero-coupon bond (definition)
A corporate bond that does not pay periodic interest income
Reinvestment risk (definition)
The risk that the rate at which periodic interest payments can be reinvested over the life of the investment will be unfavorable
Commodity price risk (definition)
The risk associated with the change in the prices of commodities that are necessary to an organization’s operations
Cash flow (definition)
Cash inflow minus cash outflow
Commodity futures contract (definition)
A contract either to make or to accept delivery of a specified quantity of a commodity on a given date
Equity price risk (definition)
The risk that changes in the price of a stock or another security will increase or decrease
Call option (definition)
An option to buy a set amount of the underlying security at any time within a specified.
Put option (definition)
An option giving the holder the right to sell a set amount of the underlying security at any time within a specified.
The two types of credit risk
Firm-specific risk and systemic credit risk
Price risk (definition)
The potential for a change in revenue or cost because of an increase or a decrease in the price of a product or an input
Price risk has these two aspects for most organizations
The price charged for the organization’s products or services
The price of assets purchased or sold by an organization
Earnings at risk (definition)
The maximum expected loss of earnings within a specific degree of confidence
Value at risk (definition)
VaR measures the probability of the loss in an investment value exceeding a threshold level. It works within a short time horizon and is typically characterized by low probability.
Three key benefits of Value at Risk as a risk measure
The potential loss associated with an investment decision can be quantified
Complex positions are expressed as a single figure
Loss is expressed in easily understood monetary terms
The primary limitation of Value at Risk
It does not accurately measure the extent to which a loss might exceed the VaR threshold
Conditional value at risk (definition)
A model to determine the likelihood of a loss given that the loss is greater than or equal to the VaR
Monte Carlo simulation (definition)
A computerized statistical model that simulates the effects of various types of uncertainty
Capital (definition)
The accumulated assets of a business or an owner’s equity in a business
Risk capital (definition)
The level of capital required to provide a cushion against unexpected loss of economic value at a financial institution, usually within a confidence interval of 95%
Equity capital (definition)
Preferred stock, surplus, common stock, undivided profits and capital reserves, and net unrealized holding gains (or losses) on securities that are not available for sale
Leverage (definition)
The practice of using borrowed money to invest
The three pillars of Basel II
Minimum capital requirements that address risk
Supervisory review
Market discipline
Economic capital (definition)
A form of regulatory capital; an estimate of the amount of capital a firm needs to remain solvent at a given risk tolerance level
How economic capital differs from other types of regulatory capital
Rather than being based on a formula, it is based on the fair (market) values of the firm’s assets and liabilities as well as their variability
Generally accepted accounting principles (GAAP) (definition)
A common set of accounting standards and procedures used in the preparation of financial statements to ensure consistency of presentation and reported results
Statutory accounting principles (SAP) (definition)
The accounting principles and practices that are prescribed or permitted by an insurer’s domiciliary state and that insurers must follow
Market value surplus (definition)
The fair value of assets minus the fair value of liabilities
Enterprise risk management (definition)
An approach to managing all of an organization’s key business risks and opportunities with the intent of maximizing shareholder value
Four examples of key economic risk factors
Gross Domestic Product (GDP)
Inflation
Financial crises, including sovereign debt crises
International trade flows and restrictions
Tariff (definition)
A tax that shields domestic producers from foreign competition
Demographics (definition)
The statistical characteristics of human populations
Political risk (definition)
Any action by a government that favors domestic over foreign organizations or poses a threat to foreign organizations
A typical framework includes these four categories of operational risk
People
Process
Systems
External events
