Lecture 12 - Risk Management

Question 1

What are the 2 ways institutions can fail

Answer 1

Becomes insolvent by suffering losses on its loan portfolio (ususally intrest rate risk) or it can be profitable but fail to meet liquidity demands of depositors, creditors or borrowers

Question 2

Explain the dilema that banks must balance

Answer 2

Banks wants to increase profits however doign so increases risk. Vice versa occurs as well because they also want to be profitable

Question 2

What is liquidity

Answer 2

Ability to fund deposit withdrawals, loan request and other disbursements when due

Question 3

What is Solvency

Answer 3

When a bank has enough money and assets to pau off all its debt in the long term. There assets are greater than their liabilities

Question 4

Give some examples of demand of liquidity

Answer 4

Accomodating deposit withdrawls, paying other liabilites they they come due, loan requests

Question 5

What are primary reserves for banks and give some examples

Answer 5

non intrest bearing and very liquid assets ( Vault Cash)

Question 6

What are secondary reserves for banks and give some examples

Answer 6

High Quality short terms earinign assets ( Goverment treasury bills)

Question 7

What is operational Risk, and give some exampels

Answer 7

Risk resulting for inadequate internal process people or systems. Examples include fraud, theft, repuational probelms

Question 7

What is credit risk of a individual loan

Answer 7

Risk that the borrow wont pay back the loan

Question 7

How do they monomize risk in their loan portfolio

Answer 7

Internal Credit ratings and loan portfolio analysis

Question 8

What is Loan Porfolio Analysis

Answer 8

Looking at concetration within specifc areas such as location, type of loan or the business they are loaning too

Question 8

What is internal credit risk ratings

Answer 8

Helps identify riskiness of credit probelms within their portfolio of loans

Question 9

Do small banks use forward looking or backward looking pricing models based on cost for credit risk

Answer 9

Backward looking

Question 10

Give a few forward looking tools that large banks use to manage credit risk

Answer 10

Risk Adjusted return on capital tool and KMV tool

Question 11

What are credit default swaps

Answer 11

The holder of a loan makes periodic payments

Question 12

What is the formula for Maturity GAP

Answer 12

RSA-RSL

Question 13

What is meant by rate sensitive

Answer 13

Less than 1 year time frame

Question 14

What does a positive duration Gab indivate

Answer 14

Net intrest income will increase if intresr rates increase

Question 15

What does a negative duration gap indicate

Answer 15

Net interest income will increase if interest rates decrease

Question 16

What are the shortcoming of the maturity GAP

Answer 16

Ignores current value of cashflows change when interest rate change, and ignores the reinvestment rate risk

Question 17

What does a positive duration Gap indicate

Answer 17

Assets have longer duraition than liabilities.

Question 18

If interest rates increase (and give versa) when a bank has a pistiive duration gap, what will happen to the the banks asset/liability value. What will happen to the banks equity

Answer 18

The assets will lose more value than the liabilities. The banks equity will lose value

Question 19

If interest rates (and vice versa) increase when a bank has a negative duration gap, what will happen to the the banks asset/liability value. What will happen to the banks equity

Answer 19

If intrest rates rice, the banks more liabilities than assets will lose value this increasing the equity for the bank.

Question 20

What is zero duration gap

Answer 20

The bank is immunized agaisnt intrest rate risk

Question 21

When a bank is asset sensitive, what does it mean

Answer 21

Asset sensitive mean that the duration of its assets is longer than its liabilities. They want intrest rates to increase

Question 22

When a bank is liability sensitive, what does that mean

Answer 22

It means that the duration of its liabilities is greater than the duration of its assets. They want interest rates to decrease

Question 23

If maturity Gap is positive, what is the duration gap the same ?

Answer 23

NO

Question 24

What is economic value analysis to measure risk

Answer 24

It is a scenario analysis based on the probablity of various economic and interest scenario

Question 25

What is Value at risk technique to measure risk

Answer 25

Uses confidence intervals based on loss potential for certain probabilities

Question 26

What is micro hedging vs Macrohedging

Answer 26

Micro heging is hedging a specifc transaction, macrohedging involves the use of risk managment instruments such as futures or options or swaps to reduce intrest rate risk