CH. 4:Operational, Fin'l, and strategic risk

Question 1

What is operational risk? and what are its categories?

Answer 1

arises from inadiquate or failed internal processes, people, and systems, or from external events. Aka; any risk that is not market or credit risk.

Categories:

1. People: eg. publicised case of discrimination’s effect on reputation.
2. process: practrices that deviates from the procedures.
3. systems: technology and equipment
4. external events: e.g. loss of key suppliers; changes in external systems the org. uses (e.g. new softwares require extra training)

Question 2

What is Financial Risk and it’s types?

Answer 2

arises from the effects of markets forces on fin’l assets or liab.

1. market risk
2. price risk
3. credit risk

Question 3

under fin’l risk, what is market risk?

Answer 3

arises from changes in the value of fin’l instruments. It has upside or downside potential.

Major categories:

1. currency price risk
2. interest rate risk
3. commodity price risk: price on input

Question 4

Under fin’l risk, what is price risk?

Answer 4

the potential for a change in revenue or cost b/c of an increase or a decrease in the price of product or an input. It has upside or downside potential.

Question 5

Under fin’l risk, what is credit risk?

Answer 5

It is basically default risk. It has only negative potential.

Question 6

What is strategic risk? and give an example.

Answer 6

arises from trends in the economy or society. They are systematic risk.

E.g. the printed-news paper; postal services

Question 7

List the 3 major strategic risks (causes of loss)?

Answer 7

1. Economic environment a.
   
   • GDP
   • Inflation
   • Financial crisi
   • International trade and restrictions
2. Demographics
3. Political environment
   
   • taxes & subsidies
   • Trade agreements & restrictions

Question 8

What is systematic risk?

Answer 8

Risk that is common to all securities of the same general class and that therefore cannot be eliminated by diversification. The company has no control over this type of risk.

Question 9

Techniques to evaluate Operations Risk:

Answer 9

Estimate future rate of injury, thru:

• Gathering data. //T table => yrs / hrs_worked / #_injuries
• Using linear regression analysis (y = a + bx). // graph => Y-axis: #_of_injuries, X-axis: hrs_Worked

Question 10

To evaluate Fin’l risk, companies use metrics such as VAR and EAR. What is Value at Risk (VAR) and Earning at Risk (EAR)?

Answer 10

Value at Risk: measure the probability of a loss in an investment’s value exceeding a threshold level (short term).

Earnings at Risk: the maximum expected loss of earnings within a specific degree of confidence.

Question 11

VaR distribution

Answer 11

Question 12

what is Monta Carlo simulation?

Answer 12

a computerized statistical model that simulates the effects of various types of uncertainity.

Question 13

How to interpret the following: VAR of $1mil with 95% confidence level or one-day 5% VaR of $1mil.

Answer 13

there is 5% chance losing $1mil (but also add context of time period)

Question 14

What is Risk Capital (for fin’l institutions )?

Answer 14

level of capital required to provide the cushion against unexpected loss of value (especially the value of asset).

Question 15

What is Economic Capital?

Answer 15

amount of capital needed to stay solvent at a given risk tolerance level. (use the VAR on)

Question 16

To survive and cover risks the company needs:

Answer 16

enough (adequate) capital

Question 17

How many types of capital are there under Basel I?

Answer 17

2 types:

1. Tire 1: equity capital (core capital)
2. Tire 2:supplementary capital other than core capital. e.g: long term bonds, potential gains on investment assets…

Question 18

According to Basel I, what are the measures of capital adequacy:

Answer 18

(a measure is basically the ratio of capital to assets):

1. [Total_capital / Risk_adjusted_assets] >/= 8%
2. [Tire_1 / Risk_adjusted_Assets] >/= 4%

Question 19

Under Operational Risk, what is KRI and Exposure indicator*

Answer 19

Key Risk Indicator: a financial or nonfinacial metric used to define and measure potential losses. it identifies issues before loss occures.

Exposure Indicator: a metric used to identify risk inherent to an org’s operations.

Question 20

What is Leverage?

Answer 20

the practice of using borrowed money to invest.

Question 21

When analysing a case study for Risk exposures, look for the following:

Answer 21

• Assets affected,
• causes of loss,
• and consequences of loss, under each of the follwoing :
  
  1. Hazzard Risk
  2. Operational Risk
  3. Finanacial Risk
  4. Strategic Risk