Chapter 18: Risk Management

Question 1

Arises out of uncertainty. It can be defined as the effect of uncertain future events on a company or on the outcomes the company achieves.

Answer 1

Risk

Question 2

Refers to the risk of losses from inadequate or failed people, systems, and internal policies and procedures, as well as from external events that are beyond the control of the company but that affect its operations.

Answer 2

Operational risk

Question 3

Relates to the risk that a company fails to follow all applicable rules, laws, and regulations and faces sanctions as a result.

Answer 3

Compliance risk

Question 4

The risk associated with investing that arises from the fluctuation in the value of investments.

Answer 4

Investment risk

Question 5

The level of risk that the company is willing and able to take on. The ability to handle risk is primarily driven by the company’s financial health and depends on its level of earnings, cash flows, and equity capital.

Answer 5

Risk tolerance

Question 6

A companys willingness to take on risk

Answer 6

Risk appetite

Question 7

Should provide a warning when risk levels are rising. They require the collection and compilation of data from various internal and external sources.

Answer 7

Key risk measures

Question 8

This risk response strategy involves accepting the risk and it’s effect. In some cases, the risk as well understood and taking it provides opportunities to create value. In other cases, the risk must be taken because other risk response strategies are unavailable or too costly.

Answer 8

Tolerance

Question 9

This risk response strategy involves taking action to reduce the risk and it’s effect

Answer 9

Treat

Question 10

This risk response strategy involves moving the risk and it’s effect to a third-party

Answer 10

Transfer

Question 11

This risk response strategy involves avoiding the risk and its effect by ceasing an activity

Answer 11

Terminate

Question 12

Investment firms set these to incorporate the companies overall risk tolerance and risk management strategy — for example, by specifiying the maximum amount of a risky security that can be held or the maximum aggregate exposure to one asset type or to one counterparty.

Answer 12

Internal risk limits

Question 13

At some point, risks must be consolidated and managed at the company level, bringing together different risks into an overall risk exposure. _____ helps a company manage all its risks together in an integrated way rather than managing each risk separately.

Answer 13

Enterprise risk management (ERM)

Question 14

Refers to situations wherein traders bypass management controls and place unauthorized trades, at times causing large losses for the companies they work for.

Answer 14

Rogue trading

Question 15

The risk that a company fails to comply with all applicable rules, laws, and regulations.

Answer 15

Compliance risk

Question 16

The risk that when settling a transaction, a company performs one side of the deal, such as transferring a security or money, but the counterparty does not complete its side of the deal as agreed, often because it has declared bankruptcy.

Answer 16

Settlement risk

Question 17

The risk that an external party will sue the company for breach of contract or other violations

Answer 17

Legal risk

Question 18

The abuse of power for private gain

Answer 18

Corruption

Question 19

The risk caused by changes in market conditions affecting prices

Answer 19

Market risk

Question 20

The risk for a lender that a borrower fails to honor a contract and make timely payments of interest and principal

Answer 20

Credit risk

Question 21

The risk that an asset or security cannot be bought or sold quickly without a significant concession in price

Answer 21

Liquidity risk

Question 22

An approach to determine how risk should be allocated among different business units, portfolios, or individuals.

Answer 22

Risk budgeting

Question 23

The risk that a government will not repay its debt because it does not have either the ability or willingness to do so

Answer 23

Sovereign risk

Question 24

Estimating the potential loss on an investment if the forecast for the investment or security turn out to be inaccurate

Answer 24

Value at risk

Question 25

The risk arising from the use of models is collectively known as _____. This risk is associated with inappropriate underlying assumptions, the unavailability or inaccuracy of historical data, data errors, misapplication of models.

Answer 25

Model risk