Market risk

Question 1

Market risk definition

Answer 1

Earnings uncertainty from changes in market prices. Arises from trading portfolio. Can be affected by other risks such as i/r or FX.

Question 2

What is trading book

Answer 2

Trading book contains assets, liabilities and derivative contracts that can be quickly bought or sold on markets. Produces trading gains or losses.

Question 3

what is banking book

Answer 3

contains all assets and liabilities. relatively illiquid and held for longer periods, like loans and deposits. produces interest income and expenses

Question 4

objectives of market risk management

Answer 4

1) quantify exposure of bank to valuation changes in trading portfolio. 2) defining strategies to cope with exposure.

Question 5

Real work example of market risk

Answer 5

Barings Bank 1992 failed due to trading losses. Nick Leeson was in charge of Barings Singapore Futures, bet $8bn that Japanese Nikkei inex would rise by buying futures. Lost $1.2bn on its trading position.

Question 6

Real world example of market risk- GFC

Answer 6

market risk was at heart of many losses in GFC. 2007, Bear Sterns hedge funds lost hugely in subprime mortgage market. 2007/8 Lehmann Bros bankruptcy.

Question 7

Benefits of measuring market risks

Answer 7

Enable mgmt to compare exposure to capital. allow setting of limits, resource allocation, performance evaluation, regulation.

Question 8

What is value at risk (VAR)

Answer 8

Potential loss that can occur on an asset or portfolio due to adverse movements in market risk variables. Measured at given level of confidence i.e. 99%. However, we don’t know what could happen in other 1%.

Question 9

What is adverse move in daily yield.

Answer 9

Bad yields are those that only have a 1% chance of happening. 2.33xSD

Question 10

what is 1 basis point in %.

Answer 10

0.01%