Lecture 12 - Risk Management Flashcards
What are the 2 ways institutions can fail
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
Explain the dilema that banks must balance
Banks wants to increase profits however doign so increases risk. Vice versa occurs as well because they also want to be profitable
What is liquidity
Ability to fund deposit withdrawals, loan request and other disbursements when due
What is Solvency
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
Give some examples of demand of liquidity
Accomodating deposit withdrawls, paying other liabilites they they come due, loan requests
What are primary reserves for banks and give some examples
non intrest bearing and very liquid assets ( Vault Cash)
What are secondary reserves for banks and give some examples
High Quality short terms earinign assets ( Goverment treasury bills)
What is operational Risk, and give some exampels
Risk resulting for inadequate internal process people or systems. Examples include fraud, theft, repuational probelms
What is credit risk of a individual loan
Risk that the borrow wont pay back the loan
How do they monomize risk in their loan portfolio
Internal Credit ratings and loan portfolio analysis
What is Loan Porfolio Analysis
Looking at concetration within specifc areas such as location, type of loan or the business they are loaning too
What is internal credit risk ratings
Helps identify riskiness of credit probelms within their portfolio of loans
Do small banks use forward looking or backward looking pricing models based on cost for credit risk
Backward looking
Give a few forward looking tools that large banks use to manage credit risk
Risk Adjusted return on capital tool and KMV tool
What are credit default swaps
The holder of a loan makes periodic payments
What is the formula for Maturity GAP
RSA-RSL
What is meant by rate sensitive
Less than 1 year time frame
What does a positive duration Gab indivate
Net intrest income will increase if intresr rates increase
What does a negative duration gap indicate
Net interest income will increase if interest rates decrease
What are the shortcoming of the maturity GAP
Ignores current value of cashflows change when interest rate change, and ignores the reinvestment rate risk
What does a positive duration Gap indicate
Assets have longer duraition than liabilities.
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
The assets will lose more value than the liabilities. The banks equity will lose value
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
If intrest rates rice, the banks more liabilities than assets will lose value this increasing the equity for the bank.
What is zero duration gap
The bank is immunized agaisnt intrest rate risk
When a bank is asset sensitive, what does it mean
Asset sensitive mean that the duration of its assets is longer than its liabilities. They want intrest rates to increase
When a bank is liability sensitive, what does that mean
It means that the duration of its liabilities is greater than the duration of its assets. They want interest rates to decrease
If maturity Gap is positive, what is the duration gap the same ?
NO
What is economic value analysis to measure risk
It is a scenario analysis based on the probablity of various economic and interest scenario
What is Value at risk technique to measure risk
Uses confidence intervals based on loss potential for certain probabilities
What is micro hedging vs Macrohedging
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
