Chapter 15

Question 1

What do banks try to do with market risk (systematic risk)

Answer 1

Try to figure out what the potential losses can be

Question 2

What is market risk

Answer 2

A systematic risk that affects everyone and can’t be hedged. This risk is from outside the bank

Question 3

What is the Volcker rule?

Answer 3

That banks need to act in the fiduciary duty of their customers

Question 4

Name the 4 ways of calculating market risk exposure

Answer 4

1) Risk metrics
2) Historic or back simulation
3) Monte Carlo
4) Expected shortfall

Question 5

What is risk metric

Answer 5

DEAR which is always expressed as a currency that is done as an exercise on portfolio assets that tells you based on market movements (interest rates, etc) how much the bank is exposed to which is done on a daily basis. Once this is done, the bank looks at the number and see if it falls within the 95% confidence interval. If yes, they leave it as is. If no, the bank looks at how they can start taking action which might be getting more reserves, etc.

Question 6

When is DEAR mostly used

Answer 6

For foreign exchange

Question 7

What is a portfolio aggregation problem

Answer 7

Term that states that you have to weight and take into account the variance and covariance of the securities according to the portfolio to find DEAR, you cannot simply add them up

Question 8

What is historic back testing approach

Answer 8

Looking at the past to try to predict the future using the same asset class portfolio

Question 9

What are some advantages of historic back testing

Answer 9

1) Simple to use
2) Directly shows the worst case scenario

Question 10

What is the biggest weakness with historical back testing

Answer 10

Hard to know how far back in the past to go in order to help us better predict the future

Question 11

What is the Monte Carlo simulation

Answer 11

Where a bank determines all the variables that could affect their loan portfolio (unemployment rate, inflation rate, etc) which creates many regression lines and run it over and over again to give many different scenarios telling you how much the bank could lose given the scenario

Question 12

What is a major advantage of Monte Carlo simulation versus historical back testing

Answer 12

Monte Carlo uses “fake” and real data that allows the bank to draw out more scenarios compared to historical only uses the past

Question 13

What is a big benefit of having a standardized framework?

Answer 13

That all FI’s can use it and compare between each other

Question 14

What is Basel 3

Answer 14

A way of managing risk in financial institutions