Class 4: Market Risk Flashcards
what is the Value at Risk (VaR) model?
Estimate of potential loss in loan portfolio over a given holding period at a given level of confidence
Probability distribution of a loan portfolio value reducing by an estimated amount over a given time horizon.
Time horizon estimate is over a daily, weekly or monthly basis.
explain/define VaR in market risk?
explain quantiles and profit & loss?
what are the three steps in VaR calculations?
which probability should we use?
what is a holding period?
Sign of VaR meaning?
what are the main issues of implementation of var?
what does Coherence mean in regards to market risk?
what does monotonicity mean in regards to market risk?
what is translation invariance?
what is positive homogeneity?
In positive homogeneity, what happens when it is violated?
what does subadditivity mean?
does VaR really violate subadditivity?
how may manipulate Var?
what is the definition of expected shortfall?
what does back testing mean?
what is the length of holding periods?
what are longer holding periods?
what are scaling laws?
what is liquidity risk?
what is interest rate risk?
Foreign exchange risk?
Forex Risk or FX Risk or exchange rate risk or currency risk
Occurs when we are valuing one currency (base currency) in terms of another currency.
Currency Pair
Base currency - appreciation
Quote currency - depreciation
Defining Exposure and Risk?
Increase in the foreign currency value increases the domestic currency value of a firm’s foreign currency assets and liabilities: foreign currency receivables and payables, bank deposits etc.,
Increase in the interest rates reduces the market value of a portfolio of fixed rate bonds and may increase the interest payouts
Increase in the rate of inflation may increase the value of unsold stocks, revenue from the future sales and future cost of production.
Thus, the firm is ‘exposed’ to unforeseen changes in the number of variables in the environment – also called as “Risk Factors”
what equity price risks?
Risk arising out of fluctuations in equity prices
High volatile stocks bear higher risk
Less volatile ones bear less risk
Impacts portfolio
what is the capital market line?
what is commodity price risk?
Uncertainty in price that adversely impacts the profit margins of producers. Also impacts users of those commodities.
Examples:
Steel prices - increases the cost of
automobile production and impacts profit
margins
Cotton, corn, wheat, oil, sugar, copper,
aluminium etc.,
what are capital adequacy norms for banking industries?
Capital Adequacy Ratio is the ratio of a bank’s capital in relation to its risk weighted assets and current liabilities.
Decided by Central Banks and Bank Regulators to prevent commercial banks from taking excess leverage and becoming insolvent in the process.
CAR = Tier I + Tier II + Tier III Capital funds / Risk Weighted Assets
Aggregate of risk weighted assets and other exposures
Assets of banks were classified and grouped in five categories to Credit Risk Weights of zero ‘0’, 10, 20, 50 and up to 100%.
Assets like cash and coins usually have ‘zero’ risk weight, while “unsecured loans” might have a risk weight of 100%
what are the constituents of capital?
what are the strategies of managing interest rate risk?
Shorten duration of bank assets or lengthen duration of bank liabilities
To completely immunize net worth from interest-rate risk, set DURgap = 0
what are the types of stress testing depending on the objective?
what are the four different types of sensitivity analysis?
one factor at a time
Multi factor at a time
regression analysis
Difference in log odds ratio
what is duration gap analysis?
Duration Gap Analysis: measures the sensitivity of a bank’s current year net income to changes in interest rate.
Requires determining the duration for assets and liabilities, items whose market value will change as interest rates change. Let’s see how this looks for First National Bank.
