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Risk Management > Chapter 4 - Managing risks > Flashcards

Chapter 4 - Managing risks Flashcards

1
Q

What is market risk also referred to as

A

Systematic risk

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2
Q

How does price volatility arise?

A

Unanticipated fluctuations in factors that commonly affect the entire financial market

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3
Q

What macro variables associated with the financial market must an investor focus on?

A
  1. inflation
  2. interest rates
  3. the balance of payments situation
  4. fiscal deficits
  5. geopolitical factors
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4
Q

What is another name for market risk and why

A

Undiversifiable risk because it affects all asset classes and is unpredictable

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5
Q

What are the four components of market risk

A
  1. Interest rate risk
  2. Exchange rate risk
  3. Commodity price risk
  4. Equity price risk
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6
Q

What are the 4 main components of market risk

A
  1. Interest rate risk
  2. Exchange rate risk
  3. Commodity price risk
  4. Equity price risk
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7
Q

What causes interest rate risk

A

Arises as a result of unanticipated fluctuations in the interest rates due to monetary policy changes by the Central bank

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8
Q

What securities are primarily associated with interest rate risk

A

Fixed income securities

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9
Q

Why do volatilities in commodity prices trickle down to affect the entire market

A

Commodities are essential for any econmand compliment the production process of many good due to their utilisation as indirect inputs

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10
Q

How do commodity risk affect the market

A
  1. Supply side crisis
  2. Decline in stock prices and performance based dividends
  3. Reduces company’s ability to honor the value of the principal itself
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11
Q

How do some emerging economies deal with foreign exchange risk

A

By maintaining foreign exchange reserves that they can sell to offset depreciation

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12
Q

What are some considerations to take into account when making an international investment

A
  1. Degree of political stability
  2. Level if fiscal deficit
  3. Proneness to natural disaster
  4. Regulatory environment
  5. Ease of doing business
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13
Q

Why do normal techniques not work for market risk

A

Market risk cannot be diversified away, it can hedged against for minimal exposure

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14
Q

What are some good measures of market risk

A
  1. Volatility
  2. VAR
  3. Beta - CAPM (measures the anticipated return of an asset)
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15
Q

In addition to VAR, what other methods exists for mitigating market risk

A
  1. Position limit
  2. Liquidity limit
  3. Performance stopout
  4. Portfolio manager limits
  5. Scenario analysis limits
  6. Leverage limits
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16
Q

Why is it difficult to measure credit risk

A

Default is rare and therefore there is very little data to help with decisions

17
Q

What are the strategies for managing credit risk

A
  1. Limiting exposure
  2. Marking to market
  3. The use of collateral
  4. Payment netting
  5. Closeout netting
18
Q

How is credit risk managed by limiting exposure

A

By limiting the quantum of loans to an individual or institutional debtor or number of derivative transactions with any counterparty

19
Q

What does the term mark to market refer to

A

The method under which the fair market values of accounts that are subject to periodic fluctuation are measured

20
Q

What is used as collateral in derivative trading

A

Margins (posted)

21
Q

When is payment netting employed

A

Used in transactions such as derivative trading where both parties have credit risk; value and net the two to determine who has a larger obligation

22
Q

When is closeout netting used

A

In bankruptcy situations

23
Q

What are the ways in which risk can be transferred to others using credit derivatives

A
  1. Credit default swaps
  2. Credit spread forward
  3. Credit spread options
  4. Total return swap
24
Q

What happens to banks whose stressed capital falls below a minimum set by regulators

A

They are prevented from making capital distributions such as dividends and stock repurchases

25
Q

What is stress testing

A
  1. An extreme scenario
  2. An extension of scenario analysis focusing on adverse outcomes
  3. A compliment to VAR
  4. It may reveal outcomes not typically captured in a VAR calculation
26
Q

What is scenario analysis typically used for

A

Typically used to estimate changes in portfolio value in response to an unfavorable event and may be used to examine a theoretical worst-case scenario

27
Q

What are the potential weaknesses in scenario planning

A
  1. Inability to measure the by-products of major factor movements
  2. The effect of simultaneous movements in risk factors

Risk Management (5 decks)

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