Credit Risk Flashcards
What is Risk?
Risk refers to the possibility of loss due to uncertainty about future event(s). It refers to the chance that an investment’s actual return will be different than expected. Risk includes the possibility of losing some or all of the original investment. Different versions of risk are usually measured by calculating the standard deviation of the historical returns or average returns of a specific investment. A high standard deviation indicates a high degree of risk.
Most business decisions are about sacrificing current resources for future uncertain returns. How comfortable is said business with sacrificing current resources?
What is Credit Risk?
Credit risk is the risk that a change in the credit quality of counterparty will affect the value of a security or a portfolio. Default risk and counterparty risk are both sub-classes of credit risk. They both refer to the possibility of loss due to non-performance of contractual obligations by its business partners.
What is the Expected Loss Formula?
Expected Loss = Probability of Loss x Amt Irrecoverable
OR
Probability of Loss x (Total Outstanding – Amt recoverable)
What is Retail Banking?
Retail banking serves both small businesses and consumers and includes the business of
accepting consumer deposits as well as that of providing consumer credit.
It encompasses:
1. Home Mortgages
2. Home Equity Loans
3. Instalment Loans
4. Credit Card Revolving Loans
5. Small Business Loans
What is Counterparty Risk?
Counterparty risk refers to
non-performance of any other contractual obligations. Traditionally, counterparty risk refers to business partners’ failure to settle trades by payment (for buyers) or delivery of securities by sellers. In more recent years, counterparty risk also refers to business partners’ failure to settle liabilities in derivative trades such as those involving trades in swaps, FX contracts, options and futures. This could refer to the periodic mark-to-market margin cash settlement
What is Default Risk?
Default risk is present only when an underlying borrower-lender relationship is created. However, counterparty risk becomes present when a firm enters into any form of financial contracts. Default risk reflects the risk non-payment of principal and coupons. Default risks exist for mainly loans and bonds.
