Risk Concepts Flashcards
state 3 differences between risk and uncertainty
- Risk can be quantified, uncertainty cannot.
- Risk is necessarily negative; uncertainty can be negative or positive.
- Risk can be insured, uncertainty cannot.
what are the three characteristics of black swan events
- Outlier
- Impactful
- Prone to be rationalized after the fact.
name 5 Canadian regulators and who they regulate
- BCBS: global rules
- OSFI: banks and insurance.
- FSRA: credit unions
- CDIC: banks
- IIROC: investment dealers
what are financial risks
risks that are unavoidable in generating profits.
what is a difference between financial and non-financial risks?
financial risks are quantifiable, non-financial risks are not.
what are 3 types of financial risk
credit, market and liquidity.
what are non-financial risks
risks that are inherent to the business
what are three types of non-financial risks
operational, cybersecurity, money laundering
what is the risk management framework?
- First line: business line.
- Second line: control functions.
- Third line: the firm’s governance, and audit.
at which step in the risk management framework is the risk profile defined?
first line by the business line
at which step in the risk management framework are the risk limits defined
the second line by the control functions.
what are 5 types of models
- Regulatory capital models
- Pricing models
- Risk models
- Business decision-making models.
- Stress testing models.
what are 6 sources of model risk?
- inaccurate, inappropriate or incomplete data.
- Inappropriate specifications.
- Flawed assumptions and mathematical errors.
- Code bugs
- Improper usage.
- Inadequate monitoring/controls.
what are the 4 levels of the risk hierarchy?
- risk profile
- risk limits
- risk appetite
- risk capacity
define risk profile
risk current amount of risk
define risk limits
the total amount of risk that management is willing to accept
define risk appetite
the total amount of risk the board is willing to accept
define risk capacity
the total amount of risk a firm can take on without failing
what are the two ways in which a company can go bankrupt
- insolvency: when a firm gradually loses money over time until it owes more than it owns.
- illiquidity: when a firm suddenly doesn’t have enough cash to cover its outflows.
what is a desired equity/assets ratio
8%
what is a criticism of the E/A ratio?
it is too crude since it doesn’t take into account what the assets and liabilities are.
what is the effect of increased deposits on E/A
E/A decreases since assets increase
what is the effect of increased earnings (interest) on E/A
E/A increases since assets and equity are both increased by a constant
what is the effect of dividends on E/A
E/A decreases since assets and equity are both decreased by a constant
what it the effect of a change in asset classes on E/A
E/A is unchanged
what is risk weighted asset
adding different weights to asset classes, an improvement over the E/A
what is the formula for RWA
RWA=12.5⋅EAD⋅K
what are three characteristics of Basel 1
- Introduction of RWA
- Introduction of exposure to a derivatives counterparty.
- Introduction of VaR
what are 4 characteristics of Basel 2
- Introduction of internal models to assess credit worthiness: PD, EAD, LGD.
- Introduction of an operational risk component to RWA.
- Introduction of the 3 pillars: capital adequacy, supervisory review, and disclosure requirements.
- Introduction of netting
what are 2 characteristics of Basel 2.5
- Supplement GMR and SR with a version calibrated on a stressed historical period so more capital is required.
- Introduction of the incremental risk charge
what is the incremental risk charge
Estimation of MTM losses from migrations in the credit book.
what are 3 characteristics of Basel 3
- Liquidity requirements
- Leverage ratio
- Standardized approach to counterparty credit risk.
