Module 55.1: Introduction to Risk Management Flashcards
What are the 3 objectives of the risk management process?
1) identify the risk tolerance of the organization
2) identify and measure the risks that the organization faces
3) modify and monitor these risks
Does not seek to minimize or eliminate risks.
What are the seven activities of the risk management framework?
1) establishing processes and policies for risk governance
2) determining the organization’s risk tolerance
3) identifying and measuring existing risks
4) managing and mitigating risks
5) monitoring risk exposures over time
6) communicating across the organization
7) performing strategic risk analysis
What is risk governance?
senior management’s determination of risk tolerance for the organization.
What is risk tolerance?
involves setting the overall risk exposure the organization will take by identifying the risks the firm can effectively take and risks the org should avoid.
What is risk budgeting?
process of allocating firm rescources to assets by considering their various risk characteristics and how they combine to meet the org’s risk tolerance.
What are financial risks?
credit risk - risk of default, counterparty
market risk - uncertainty of market prices
liquidity risk - having to sell at a time when market conditions are low
What are non-financial risks?
1) operational risk - human error, inadequate security, business interuptions
2) solvency risk - unable to operate because ran out of cash
3) regulatory risk - regulatory environment will change and hurt business
4) governmental or political risk - tax risk
5) legal risk - strong change of future legal action
6) model risk - valuation models are incorrect
7) tail risk - extreme events are more likely than analysis indicates
8) accounting risk - accounting policies are incorrect
What is mortality risk and longevity risk?
risk of death and not having enough cash to cover families future needs.
How is standard deviation a measurement of risk?
measure of volatility of asset prices and interest rates. may not be accurate if distribution has negative skew or positive excess kurtosis.
How is beta a measurement of risk?
measures market risk of equity securities and portfolios of equity securities. considers the risk reduction benefits of a diversified portfolio.
How is duration a measurement of risk?
measures the change in debt prices due to changes in interest rates.
What are the four derivative risk measurements? aka the Greeks.
1) Delta - sensitivity of derivatives values to the price of underlying asset
2) Gamma - sensitivity of delta to changes in the price of the underlying asset
3) Vega - sensitivity of derivatives to the volatility of the price of the underlying asset.
4) Rho - sensitivity of derivatives values to changes in the risk free rate.
What is “value at risk” VAR?
minimum loss over a period that will occur with a specific probability. for example $1mm at 5% means that the minimum loss a bank will face 5% of the time is $1mm.
What is conditional VAR?
expected value of a loss given that loss exceeds a minimum amount. similar to losses expected given default on a bond.
What is a risk transfer?
another party takes on the risk of a firm. Insurance is a type of risk transfer.
