CISI Risk - Chapter 5 Flashcards
What is market risk
The risk or loss of earnings or capital from changes in the value of financial instruments
4 assets effected by Market Risk?
Money market instruments & Bonds
Equities
Commodities
Derivatives
What is a direct factor
Directly reflect the performance of a company, such as management
What is a Indirect factor
Indirectly effects performance of the firm, like macroeconomic variables.
What is Market Liquidity Risk
The risk of loss through not being able to trade in a market. Ie not being able to sell at the price you want when you want
What is volatility risk
Price movements, can be adverse or expected
What is currency risk
Adverse movements in exchange rates
What is basis risk
Risk that instruments behaves in a similar, but not identical, manners.
What is basis risk usually associated with?
Derivatives and hedging with them
What 4 instruments does interest rate risk effect
Fixed income securities, Futures, Options 7 Forwards
What is (H)edging
Reducing the risk of adverse price movements by taking an offsetting position in a related product
What is Market Risk Limitations
Specifying the max acceptable loss
What is usually used in to aid Market Risk Limitations
Stop-Loss limits
What is diversification
Eggs in many many baskets
What can HFT firms offer?
Tight price speads
How are the models in a market risk management function validated?
Independent validation
What is distribution analysis
Statistical means of using historical data to predict future events. Uses probability distributions
What is another name for the term Typical Value
Central tendency
What curve does normal distribution have?
Bell Curve
What % of confidence level will be in the mean in standard deviation
68
What is the equation for Quartile Deviation
0.5 (Q3-Q1)
What is Beta ?
How closely a portfolio mirros that of the general market
What is distribution analysis
Using historical data to predict future events
What distribution exhibits “Fat Tails”
Normal Distribution
What is regression analysis
Relationship between vairables
How is Regression analysis displayed?
Scattter-gram
What is a positive correlation?
An increase in price of one share is associated with the increase in another
What is negative correlation
An increase in price of one share is associated with the decrease in another
What does an asset with a Beta of 0 mean?
Price is not correlated to the market at all
What does an asset with a Beta of 1 mean?
It follows the market
What does an asset with a Beta of -1 mean?
It goes against the market
What is optimisation
Portfolio construction techniques that obtain the best expected returns from the right mix of assets
What is VAR
Value at risk, the maximum loss that can occour over a specific time period and confidence level
3 advantages to using VAR
Provides a statistical probability of potential loss
Readily understood by non-risk managers
Common standard
Main disadvantage to using VAR?
Events/losses outside the confidence level
What is Historical Simulation
Looking back at past data and predicting the future
What is the parametric approach?
The distribution of returns can be plotted and the data can be “Read off a graph”
Advantage of Historical Simulation
Conceptually simple and no need to estimate volatilizes
Main disadvantage to Historical Simulation?
Assumes history will repeat itself
How are returns distributed in the Parametric Approach
Normally Distributed
Main advantage of the parametric approach
Simple methodology, little computation
Main disadvantage of the parametric approach
if actual returns are not normally distributed, the results will be inaccurate
What instrument can NOT be used with the parametric approach?
Securities
What is the Monte Carlo simulation
Producing random numbers and using them to plot return distribution
Main advantage of the Monte Carlo approach
Can be used for non-normally distributed instruments
What instrument would utilize the Monte Carlo approach
Options
What is the main disadvantage of the Monte Carlo Approach
Computing power required is HEFTY
What is back testing
Comparing the actual daily trading exposure to previously predicted VAR figure
