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CISI Cards - Risk in Investment > CISI Risk - Chapter 4 > Flashcards

CISI Risk - Chapter 4 Flashcards

1
Q

What is default risk

A

Risk of loss caused by the failure of a counterparty or issuer to meet obligations

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2
Q

What is a counterparty

A

A party of either side of a trade.

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3
Q

What is an obligor?

A

The party that has the financial obligation

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4
Q

What is the goal of credit risk management?

A

Maximize a firms risk-adjusted rates of return

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5
Q

What is issuer risk

A

The risk that the issuer defaults on its obligations

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6
Q

2 examples of issuer risk

A

Bond issuers defaults on coupon payments
Bankruptcy of issuer before redemption

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7
Q

What is pre-settlement risk?

A

The risk a firm defaults before the settlement of a transaction

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8
Q

What risk effected Northern Rock in 2007-8?

A

Credit risk - Short term loans

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9
Q

What us settlement risk

A

Default of a counterparty during a non-DVP transaction

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10
Q

What is DVP?

A

Simultaneous exchange of cash for assets

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11
Q

What is PVP

A

Payment vs Payment - Simultaneous exchange of one currency for another

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12
Q

What is RFP?

A

Receipt Free of Payment. Asset & Cash are transferred indecently of each other

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13
Q

Credit Risk boundaries - What is People

A

Adequate segregation of duties

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14
Q

Credit Risk boundaries - What is Systems?

A

The accuracy and timeliness of credit risk information to management by systems

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15
Q

Credit Risk boundaries - What is Internal Processes

A

The efficiency and effectiveness of the credit administration process

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16
Q

What two parts make up credit exposure?

A

Current exposure and potential future exposure

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16
Q

What is credit exposure?

A

The amount that could be potentially lost if a debtor defaults on its obligations

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17
Q

What is a credit risk premium.

A

The interest rate a firms pays to borrow compared with the risk free rate. Higher risk higher premium

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18
Q

What is a credit rating

A

How creditworthy a counterparty is.

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19
Q

The higher the credit rating, the higher or lower the premium?

A

Lower premium

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20
Q

4 Credit rating agencies

A

Fitch
Moods
SnP
DBRS

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21
Q

2 issues with credit rating agencies

A

Opinion based and size/amount of losses are ignored

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22
Q

What rating will a firm need to have to be Investment grade?

A

AAA-BBB

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23
Q

What rating will a firm need to have to be Speculative Grade?

A

BB-D

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24
Q

How is potential exposure usually measured?

A

Statistical techniques such as Value at Risk (VAR)

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25
Q

What are hard factors in credit ratings?

A

Factual variables that would effect a credit rating?

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26
Q

What are soft factors in credit ratings?

A

Subjective variables that would effect a credit rating

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27
Q

6 specific criticisms of credit ratings

A

no capture of market or liquidity risk
Opinion only
Downgrades have not happened quickly enough
Rating agencies have been too familiar with company management
Recent errors of judgement in grading structured products
Too reactive

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28
Q

Expected loss = ? X ? X ?

A

PD X EAD X LGD

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29
Q

What does PD stand for

A

Probability of default (%)

30
Q

What does EAD stand for

A

Exposure at default (Amount)

31
Q

What does LGD stand for?

A

Loss Given Default

32
Q

What is the equation for the recovery rate?

A

RR = 100% - LGD

33
Q

What is a credit event

A

A recognished industry trigger point

34
Q

What are some examples of a credit event

A

Bankruptcy, Insolvency, receivership, failure to meet payments or a credit rating downgrade

35
Q

What is wrong way risk

A

The issuing company offer up collateral of their own stocks/assets

36
Q

What is a non-performing asset

A

Payments missed for 90 days or more become non-performing

37
Q

If payments are late for a short time, what are they classed as?

38
Q

5
Limitations on credit risk management

A

Reliant on quality historical data
Lack of recognition of portfolio diversification
Lack of recognition of the time period of credit risk
Over simplification of calculation of potential exposure
Similar exposures do not have equal credit risk

39
Q

What is a notional amount?

A

Charges applied on potential exposure instead of current exposure

40
Q

What are underwriting standards?

A

Criteria for evaluation of a counterparties creditworthiness

41
Q

What is a Guarantee?

A

Like an insurer that will pay out if the borrower does not pay back the loan

42
Q

What is a netting agreement?

A

A netting agreement allows two parties that exchange cash flows to net cash flows to a single payment

43
Q

What is a Unilateral arrangement?

A

One party gives collateral to another

44
Q

What is Bilateral arrangement?

A

Two-sided obligations.

45
Q

What uses bilateral arrangements?

A

Swap or FX trade

46
Q

What is Netted?

A

The party who is the net obligor posts collateral for the value of the net obligation (They baso add up all the stuffs and provide one single large overarching collateral)

47
Q

What is a ‘Haircut’

A

Additional collateral used to offset rises or falls in the collaterals market price

48
Q

How to calculate haircut?

A

Take the bond amount and X by the haircut %.

49
Q

If £20 Million of AAA bonds are being held as collateral and the haircut is 4%, how much collateral is it?

A

20 Million + (20 Million x 1.04) = 20.8Million

50
Q

What is asset securitisation?

A

Bundling loans together and selling them to investors

51
Q

What are Loan Sales?

A

Selling on a loan to an investor. Sorta like re-purcahse

52
Q

What is a Credit Default Swap (CDS)

A

Optional insurance to cover any potential losses from a default from a counterparty

53
Q

What is an SPV used in?

A

Special Purpose Vehicles used in securitization

54
Q

At what point will a CDS Payout?

A

During a credit event. Downgrades are not normally included in this

55
Q

What is a CCP

A

A guarantor of all transactions, limiting the exposure to the clearing house and protecting parties from default

56
Q

What is novation?

A

Two trading parties offsetting the transaction to the CCP.

57
Q

3 ways CCPs gain resources to protect from default

A

Their members
Fees by the exchange
Other parties that do not have a direct relationship with their market

58
Q

Who approves the credit risk management function?

A

Board of directors

59
Q

What is a credit risk managment function?

A

Maxamise a firms risk adjusted rate of return by managing credit risk exposure with acceptable limits

60
Q

Who implements the credit risk strategty?

A

Senior Managers

61
Q

3 things that happen in a credit risk management function?

A

Credit risk analysis
Credit decisions are made independently of trading
Integrate credit risk management into general business strategy

62
Q

How often should a firms credit risk strategy be reviewed?

62
Q

Who is responsible for approving and reviewing the firms credit risk strategy?

62
Q

4 things the measurement of credit risk should take account of?

A

Specific nature of the the credit
The exposure profile
The existence of collateral
The potential for default

63
Q

5 components to credit scoring systems

A

Age
Credit history
Occupation
Years in current job
Home owner or renting

64
Q

What are the 2 extraordinary inputs included in a credit assessment?

A

Court actions and one off factors

65
Q

What are split ratings>

A

A financial instrument recieves many many ratings

66
Q

What is the most popular way of measuring Concentration risk?

A

Herfindahl-Hirschman index.

67
Q

Advantage to the HHI index?

A

Simple computing and moderate data requirments

68
Q

Disadvantage to the HHI index?

A

Not consider borrowers credit quality

CISI Cards - Risk in Investment (19 decks)

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