LM 6: Introduction to Risk Management

Question 1

What is risk exposure?

Answer 1

sensitivity to a certain risk that is quantified

example, banks have assets and liabilities that are sensitive to interest rate risk

Question 2

What is risk management?

Answer 2

process involves
1. setting an optimal level of risk exposure
2. measuring the actual level of risk exposure
3. making any necessary adjustments to reach the target level

Question 3

What is risk management framework?

Answer 3

infrastructure, processes, and analytics to support effective risk management.

Question 4

What are the 7 keys factors to risk management framework? RRRDRCS

Answer 4

-risk governance

-risk identification & measurement

-risk infrastructure

-defined policies & processes

-risk monitoring, mitigation, and management

-communications

-strategic analysis or integration

Question 5

What is risk governance?

Answer 5

top down process that directs risk management activities to support overall enterprise, usually performed at board level.

Question 6

What is risk identification & measurement?

Answer 6

organization’s potential risk exposures should be assessed qualitatively and quantified as accurately as possible.

Question 7

What is risk infrastructure?

Answer 7

people & systems needed to track risk exposures & assess an organizations risk profile

Question 8

What is defined policies and processes in the risk management framework?

Answer 8

risk management committee that focuses on the specific day to day operations and decisions

Question 9

What is risk monitoring, mitigation, & management?

Answer 9

continuous monitoring of the situation is needed to determine if a risk exposure is out of line

Question 10

What is communication in risk management framework?

Answer 10

Relevant information about risk management must be clearly communicated throughout an organization.

Question 11

What is strategic analysis or integration?

Answer 11

Good risk management is key to increasing a company’s value. A well-integrated risk management strategy can help identify activities that add value as well as those that may be destroying value.

Question 12

What 3 things does the board do in terms of risk governance? SRR

Answer 12

1. set goals
2. risk tolerance
3. risk budgeting

Question 13

What does management do in terms of risk governance from board level ? IARI

Answer 13

goals > implement strategies

risk tolerance > allocate to risky activities

risk budgeting > risk exposures

implement policies & procedures

right of arrow is everything management does.

Question 14

What is the risk management infrastructure 5 specific activities?

Answer 14

identify risks > measure risks > monitor risks > reports (communications) > strategic analysis

Question 15

What are the 3 responsibilities of risk management committee (aka governing body)? PDS

Answer 15

1. providing risk oversight
2. determining organizational goals & priorities
3. specifying risk tolerance (which risks and levels of exposure are acceptable)

Question 16

What is enterprise focused risk management?

Answer 16

risk management that takes a holistic (whole) view of the firm

Question 17

What does the chief risk officer do?

Answer 17

responsible for building & implementing the risk management framework

Question 18

What is risk tolerance?

Answer 18

identifying how much an organization is willing to lose by accepting exposure to certain costs

Question 19

What is risk budgeting?

Answer 19

deciding the amount of risk to take on in a portfolio and subdividing the risk over the return sources

Question 20

Whats the difference between financial risk and non financial risk?

Answer 20

financial risk originate from financial markets

non-financial risk are outside of financial market environment and could be of environmental or regulatory changes.

Question 21

What is the correct sequence of events for risk governance and manager that focuses on the entire enterprise?

risk budgeting, risk exposures, risk tolerance

Answer 21

1. risk tolerance
2. risk budgeting
3. risk exposures

Question 22

What are the 3 types of financial risk, describe them?

Answer 22

-market risk (movements in interest rates, exchange rates ,etc that move the market)

-credit risk (the probability of a financial loss resulting from a borrower’s failure to repay a loan)

-liquidity risk (inability to pay short term obligations)

Question 23

What are 8 non financial risks? SLCMTOSR

Answer 23

1. settlement risk
2. legal risk
3. compliance risk
4. model risk
5. tail risk
6. operational risk
7. solvency risk
8. risks unique to individuals

Question 24

What is settlement risk, legal risk, and compliance risk?

Answer 24

settlement risk: possibility of one or more parties fail to deliver on terms of contract

legal risk: sued for various legal reasons

compliance risk: an organization’s legal, financial and criminal exposure if it does not follow industry laws and regulations.

Question 25

What is model risk, tail risk, and operational risk?

Answer 25

model risk: loss resulting from using inaccurate models to make decisions, tail risk: investment will move more than three standard deviations from the mean is greater than what is shown by a normal distribution. operational risk: risk from people and processes used by companies to produce the output

Question 26

What is solvency risk and risks unique to individuals?

Answer 26

solvency risk: risk the entity does not survive because it lacks the cash needed to fund day-to-day operations. risks unique to individuals: Individuals face non-financial risks to their property (e.g., theft, damage) and their health.

Question 27

What are the 4 metrics used to measure risk of derivatives, describe them?

Answer 27

1. delta (sensitivity of derivative price to underlying asset) 2. gamma (sensitivity of delta to underlying asset) 3. vega (sensitivity of derivative price to volatility of underlying asset) 4. rho (sensitivity of derivative price change in interest rates)

Question 28

What are 5 other common metrics used to quantify risk exposure, outside of derivative risk metrics? PSBDV

Answer 28

1. probability 2. standard deviation 3. beta 4. duration 5. value at risk (VAR)

Question 29

What is value at risk or VAR? and what does VaR is £3 million at 5% for one day?

Answer 29

specifies minimum loss over a given time period, at a given probability 5% of the time they'll expect to lose at least 3 million in one day.

Question 30

What is duration?

Answer 30

measures the sensitivity of a fixed income instrument to interest rates

Question 31

Whats the difference between scenario analysis and stress testing?

Answer 31

scenario analysis models market conditions that put pressure on a portfolio stress test focuses on the change in just one variable

Question 32

What is risk modification?

Answer 32

aligning risk levels with what has been determined to be acceptable.

Question 33

What are the four broad categories of risk modification?

Answer 33

1. risk prevention & avoidance 2. risk acceptance 3. risk transfer 4. risk shifting

Question 34

What are the two ways risk can be mitigated internally in regards to risk acceptance?

Answer 34

self-insurance or diversification

Question 35

What is risk avoidance?

Answer 35

you avoid the project because of the risk

Question 36

What is risk acceptance?

Answer 36

a strategy in which the organization accepts the potential risk and proceed to make investment

Question 37

What is risk transfer?

Answer 37

A pure risk is transferred from the insured to the insurer, who typically is in a stronger financial position

Question 38

What is risk shifting and 2 tools used?

Answer 38

the firm accepts and attempts to mitigate the risk, usually through derivatives. tools: forward commitments & contingent claims

Question 39

What is adverse risk interaction?

Answer 39

when losses caused by one type of risk exacerbate losses caused by another type of risk.

Question 40

What 2 things should risk tolerance of an organization reflect, describe them?

Answer 40

reflect both an an inside and outside view. 1. The inside view asks what level of loss will leave the organization unable to meet critical objectives. 2. The outside view asks what sources of uncertainty or risk the organization faces.