Chapter 39 - Sources Of Risk Flashcards

1
Q

What is systematic risk?

A
  • Risk relating to a whole financial system or market
  • Cannot be diversified away
  • You get rewarded for taking extra risk
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

What is diversifiable risk?

A
  • Risks relating to an individual component of a financial system or market
  • Can be diversified away
  • Not rewarded for taking extra risk
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

What are the main risk source categories?

A
Market
Liquidity
Credit
Operational
External
Business
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

Give examples of credit events.

A
Credit rating goes down
Failure to pay
Insolvency/wind-up/Bankruptcy
Chance in credit spread
Reputation
Cross default
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

What are the credit risks?

A

Credit risk = risk that a 3rd party fails to meet their obligations of a financial transaction

  1. Asset default
  2. Counterparty risk ->settlement risk
  3. General debtors
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

What is liquidity risk and market liquidity risk?

A

Liquidity risk = the company is solvent but does not have sufficient financial resources to meet its liability obligations or can only do so at an excessive cost

Market liquidity risk = the market does not have the capacity to handle the volumes of assets to be bought or sold without having an effect on the price

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

What is the difference between liquidity and marketability?

A

Marketability -> how quickly can you sell it

Liquidity -> how quickly can you sell it at a predictable price

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

How can a company manage liquidity risk?

A
  • Hold liquid assets
  • Sell illiquid assets
  • Borrow money
  • Allow for seasonal variations
  • Allow for margins in withdrawals to be high
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

What is market risk?

A

It is the risk of a change in the investment market values, or any other factor related to the investment market for example interest rates, inflation, economic conditions or currency movements.

  1. Asset valuation
  2. Liability valuation
  3. A-L mismatching
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

What is the market risk related to A-L modelling?

A
  • Range of assets available
  • Duration of available assets
  • L can include options
  • L can include discretionary benefits
  • Cost of matching may be too high

Mismatch = liquidity and reinvestment risk

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

How can you reduce credit risk?

A
  1. Security which depends on
    - Nature of transaction
    - Borrower covenant
    - Negotiating strength
    - Market conditions
    - Availability
  2. Credit ratings
    - Moody’s
    - Standard and Poor’s
    - Fitch
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

What are the canons of lending?

A
  1. Is the character of borrower satisfactory?
    - Known
    - Competent
    - Trustworthy
    - References
    - Defaulted before
    - Depth and spread of skills and experience
    - Due diligence
  2. Is purpose valid and will money be put to good use
    - Sector concerns
    - Ethical and moral considerations
    - Controls on application of money
    - Expansion or running costs
    - Other risks (country, currency, environmental, resource, technological + inherent)
  3. Is amount reasonable
    - For purpose
    - Who looses if project fails
    - Own contribution
  4. Repayment
    - Affordability
    - Source of funds
    - Asset and income cover
    - How certain it is
    - Credit rating
    - Higher ranking debt
    - Covenants or constraints
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

What are external risks?

A

Risk of losses occurring from an external event

  • fire, flood, earthquake, storm, war, terrorist attack
  • legislative changes, mergers of competition
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

What are operational risks?

A
Risk of failure or inadequate internal processes, people and systems
Can be managed
- Data erros
- Admin complexity
- Management actions
- Dominance risk
- Inadequate risk control measures
- Fraud
- Failure to mitigate external risk
- Failure to have recovery plans
- Reliance on 3rd party
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

Name the business risks.

A
Volume of business
Options and guarantees
Withdrawals
Mix of business
Underwriting cycle
Reinsurance
Claims
Expenses
Competitors
Financing
Exposure
Underwriting risk
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

Why is reinsurance a risk?

A
Inadequate cover
Costs too high
Availability
Poor value for money
Failure to understand cover
Underinsured
17
Q

Why is competitors a risk?

A

Inferior products
Prices uncompetitive
Less innovation -> less new business
Allowed for changes in legislation

18
Q

What are the expense risks?

A

Inflation
Mismatching
Inadequate spreading of fixed expenses
Higher than expected (admin, development, sales etc)

19
Q

What are the claim risks?

A
Amount
Frequency
Volatility
Currency
Court-awarded inflation
Claim delays
Claim handling
Loose policy wording
P/h characteristics
Legislation